FOREIGN INVESTMENT AND THE BARGAINING PROCESS:
CASE STUDY OF THE ALUMINUM INDUSTRY IN ICELAND
by
J6n Bjorn Skiilason
B. S., University of Iceland 1992
THESIS SUBMITTED IN PARTIAL FULFILLMENT OF
THE REQUIREMENTS FOR THE DEGREE OF
MASTER OF ARTS
in the Department
Geography
@
J6n Bjorn Slailason 1994
SIMON FRASER UNIVERSITY
October, 1994
All rights reserved. This work may not be
reproduced in whole or in part, by photocopy
or other means, without permission of the author.
APPROVAL
Name:
J6n Bjorn Skiilason
Degree:
Master of Arts
Title of Thesis:
Foreign Investment And The Bargaining Process:
Case Study Of The Aluminum Industry In Iceland
Examining Committee:
Chair:
I. Hutchinson, Associate Professor
I
R. Hayter, ~r8fessor
Senior Supervisor
S.T. Wong,
Professor
I
/,-
~untefkrumme,4rofessor
Department of Geography
University of Washington
External Examiner
Date Approved:
October 4. 1994
--
-
-
PARTIAL COPYRIGHT LICENSE
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for one of its users. I further agree that permission for multiple copying of this work for
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understood that copying or publication of this work for financial gain shall not be allowed
without my written permission.
Title of Thesis/Project/Extended Essay
Foreign Investment And The Bargaining Process: Case m
Industry In Iceland
J6n Bjorn Skdlason
(name)
y Of The Aluminum
ABSTRACT
The central research theme of this thesis is to explain the actual and planned
investments in the aluminum industry in Iceland in terms of the bargaining process that
took place between the Icelandic government and aluminum multinational corporations.
The first of these negotiations were between the Icelandic government and Alusuisse
between 1961-1966, which resulted in the establishment of the ISAL aluminum smelter,
and the second with the ATLANTAL-group between 1987-1991. The latter negotiations
formally ended in 1991 without the establishment of an aluminum smelter. However,
informal negotiations have continued and a new aluminum smelter in Iceland is possible as
soon as economic factors make the project justifiable. This thesis seeks to examine in
detail both bargaining processes and compare them to assess how spin-offs from the first
bargaining process affected the second.
The thesis explicitly interprets industrial location as a bargaining process. The
underlying rationale is that location conditions are not provided by nature or universal
economic laws but are socially constructed by powerful institutions, like governments and
big corporations. In order to understand the nature of location decision-making, its
implication for local development, and the creation of location conditions it is necessary to
examine negotiations that commonly precede foreign investment.
The main information sources for the thesis are governmental documents,
newspaper articles, and interviews with some key participants in the negotiations. It
should be noted that some of the governmental documents regarding the first case were
marked confidental but are now open to the public as they are more than 25 years old.
This research demonstrates the validity of interpreting investment in the Icelandic
aluminum industry as a bargaining process. In both case studies, negotiations focused on a
few key issues, notably, location, taxation, power supply, and legal issues. While both
parties had different priorities and an agreement was reached, viable alternatives were
eschewed. Particular controversial matter involved negotiations over the location of the
second smelter which is planned to be next to the existing smelter although the
government preferred a different location. The government's bargaining position has
strengthened during the last three decades through spin-offs and learning from
negotiations with MNCs. However, the government's bargaining power has only increased
a little, as the bargaining power is a result of competition between countries attracting the
same or similar industries. This competition gives big MNCs advantages in some areas as
they can exploit and compare one location to another.
Though the future of the aluminum industry, or power intensive industry, in
Iceland is bright, MNCs should be attracted cautiously and the bargaining process should
be used to maximize Iceland's benefits and eliminate undesirable factors such as pollution.
ACKNOWLEDGMENTS
First, I would like to thank Dr. Roger Hayter, my senior supervisor, for his
encouragement, constructive thoughts, assistance and advice that kept this work going
and for our h n conversations about English football which enlivened many long days. I
thank Dr. S.T. Wong, my other committee member, for good advice and quick responses.
I would like to express gratitude to my interviewees Dr. Johannes Nordal (Chairman of
TIDC and Chairman of the Board of the National Power Company), Jon Sigurbsson
(former Minister of Industry) and Ragnar S. Halldorsson (ISAL7sChairman of the Board),
and I also thank Halldor Blondal Wnister of Agriculture) for giving good insight. I
express special thanks to Emil Boasson (Institute for Regional Development) for his
advice and comments. I thank employees at ISAL aluminum smelter who were all more
than willing to provide all the help they could give and I also thank Jonas Finnbogason
(Central Bank of Iceland, Library), isak 0lafsson (Mayor of ReyBarfjorBur), and
geographer Magnus Baldursson for their assistance. My good friend Sigurbur F.
Meyvantsson gets my gratitude for his assistance in making my fieldwork possible and
pleasant.
I am also extremely gratefbl to S t e i n u ~Hauksdottir, my fiancee, for her
indefatigable job enhancing my computer skills, her patience and her interest in the subject.
I also would like to thank my fellow graduate students Larry Peach, Peter de Wolf, John
Martin and Dale McKendrick for showing interest in the subject and good times.
Finally I would like to thank my parents, Skdi 0lafs and GuBbjorg R. Jonsdottir,
as without their assistance and support this project would never had been possible,
'thanks'.
CONTENTS
...................................................................................................................i
..
ABSTRACT...................................................................................................................
...
ACKNOWLEDGEMENTS .........................................................................................
LIST OF TABLES........................................................................................................ix
LIST OF FIGURES.......................................................................................................
x
APPROVAL
11
111
.
CHAPTER I INTRODUCTION
..................................................................................1
................................................................................ 2
LOCATION
AS BARGAINING
PROCESS
........................................................................................................... 8
RESEARCH DESIGN
Iceland ...................................................................................................................
10
.
CHAPTER I1 THE BARGAINING PROCESS BETWEEN MULTINATIONAL
14
CORPORATIONS AND HOST COUNTRIES
..........................................................
.......................................................................... 21
MODELSOF THE BARGAINING
PROCESS
The Structure of Bargaining Situations...................................................................... 22
The Nature of the Bargaining Process between MNCs and HC(G)s ........................... 28
The Bargaining Process after Investment...................................................................36
Spin-offs from Learning ........................................................................................3 7
Spin-offs from Bargaining ...................................................................................... 37
Obsolescing Bargaining ..........................................................................................
38
CHAPTER m.GLOBAL DEVELOPMENT OF THE ALUMINUM INDUSTRY 43
INTRODUCTION .............................................................................................................. 43
LOCATIONSTRATEGIES
AND BARGAINING
IN THE ALUMINUMINDUSTRY
.........................55
Electricity and Bargaining ...................................................................................5 7
.
CHAPTER IV THE BARGAINING PROCESS BETWEEN THE ICELANDIC
GOVERNMENT AND ALUSUISSE (1960-1966)
63
.....................................................
............................................................................. 66
THENATIONAL
CONTEXT
OF DEBATE
The Debate within Iceland ...................................................................................... 68
Alusuisse Options ...........................................................................................7
3
........................................................................ 75
OBJECTIVESAND MOTIVATION
FACTORS
Icelandic Government ..................................................................................... 7
5
Alusuisse................................................................................................................ 79
INTERACTIONS
BETWEEN THE ICELANDICGOVERNMENT
AND ALUSUISSE
........................ 79
The Location Question within Iceland .................................................................... 80
Power Supply ....................................................................................................... 85
Taxation ................................................................................................................ 89
Import Duties......................................................................................................... 92
Legal Issues ............................................................................................................ 92
Duration of the Master Agreement ......................................................................... 94
vii
.
CHAPTER V THE BARGAINING PROCESS BETWEEN THE ICELANDIC
GOVERNMENT AND THE ATLANTALGROUP
..................................................98
.....................................................................................................................
CONTEXT
100
Iceland ................................................................................................................. 101
The ATLANTAL-Group ......................................................................................
106
......................................................................
OBJECTIVES
AND MOTIVATION
FACTORS
107
Icelandic Government .......................................................................................... 107
ATLANTAL.Group .............................................................................................
108
INTERACTIONS BETWEEN THE ATLANTAL-GROWAND THE ICELANDIC GOVERNMENT 110
The Location Question within Iceland .................................................................. 112
Reybarfjorbur Region ....................................................................................... 118
Eyjafjorbur Region ........................................................................................... 121
Reykjanes Region ............................................................................................. 124
Power: Price and Supply ...................................................................................... 127
Taxation .............................................................................................................. 129
Import Duties....................................................................................................... 130
Legal Issues ......................................................................................................... 130
Duration of the Agreement ................................................................................. 130
Xhe Status of the Negotiations, 1991-1994............................................................... 131
.REFLECTION
................................... 134
DELAYIN THE ATLANTAL PROJECT
ON TIMING
.
CHAPTER VI CONCLUSION
................................................................................139
.................................................................................... 139
THEBARGAINING
FRAMEWORK
THE CASESTUDIES
COMPARED:BARGAINING.
SPIN-OFFS
AND POWER
......................... 142
..........................................................................................................146
REFERENCES
APPENDIX 1 MEMORANDUM BETWEEN THE ICELANDIC
GOVERNMENT. ALUSUISSE AND THE WORLD BANK
.................................157
...
Vlll
APPENDIX 2 PRELIMINARY AGREEMENT BETWEEN THE ICELANDIC
GOVERNMENT AND THE ATLANTALGROUP
161
................................................
LIST OF TABLES
3.1. WORLDTRENDSIN PRODUCTION
OF ALUMINUM INGOTS 1970 AND 1990................. 4 8
3.2. SHARESOF THE SIXMAJORSIN WORLD BAUXITE,
ALUMINA, AND PRIMARY
ALUMINUM CAPACITIES: 1955, 1963, 1971, AND 1979 (IN PERCENTAGES AT
START OF THE YEAR)+. ........................................................................................... 5 2
4.1. CHRONOLOGY OF EVENTS
DURING THE NEGOTIATIONS
BETWEEN THE ICELANDIC
GOVERNMENT AND ALusUISSE 1960-1969. ............................................................ 67
4.3. QUESTIONNAIRE FROM ALUSUISSE TO THE ICELANDIC GOVERNMENT.
...................... 7 8
4.4. CAPITAL COST COMPARISON, FOR A 3 0.000 TON ALUMINUM SMELTER, BETWEEN
TWO SITES IN ICELAND,
STRAUMSV~AND GASEYRI. ..... ......................................... 8 1
5.1. CHRONOLOGY OF EVENTS
DURING THE NEGOTIATIONS
BETWEEN THE ICELANDIC
GOVERNMENT AND THE ATLANTAL-GROUP 19 87- 1994. .................................... 10 1
5.3. COST ESTIMATES
FOR FACILITIES
IN RELATION TO CONSTRUCTION OF AN ALUMINUM
SMELTER
IN 5 LOCATIONS
IN ICELAND
(NOT INCLUDING CONSTRUCTION OF THE
SMELTER ITSELF). ................................................................................................. 114
LABOUR
FORCE(ESTIMATES) NEEDED
FOR CONSTRUCTIONS AND
5.4. TOTAL
OPERATION OF AN 200,000 TON ALUMINUM SMELTER AND NEW POWER
PLANTS
(MAN-YEARS). ......................................................................................... 115
LIST OF FIGURES
2.1. FACTORS
AFFECTING A MNC-HC BUSINESS
RELATIONSHIP.....................................2 9
2.2. A SIMPLIFIED
MODELOF THE BARGAINING
RELATIONSHIP
BETWEEN A M N C
AND Hc ................................................................................................................
3 0
2.4. INTERACTION BETWEEN A M N C AND A H C ABOUT A POSSIBLE
BUSINESS
RELATIONSHIP ........................................................................................................ 34
2.5. COMPONENTS OF THE BARGAINING
RELATIONSHIP
BETWEEN M N C AND H C ............ 3 9
3.1. PRODUCTION AND CONSUMPTION OF ALUh4lNUM JNGOTS 1950-1990 .......................46
5.2. REYDAFSJoRDUR REGION AND POSSIBLE
SITESFOR POWER
INTENSIVE INDUSTRY. 119
5.4. EYJAFJORDURREGION AND POSSIBLE
SITES FOR POWERINTENSIVE INDUSTRY...... 123
SITES FOR POWERINTENSIVEINDUSTRY .......... 125
5.6. REYKJANES REGION AND POSSIBLE
5.7. POPULATION
CENTERS IN THE REYKJANEs REGION AND POSSIBLE LABOUR POOL FOR
AN ALUMINUM SMELTER LOCATED
AT KEILISNES................................................. 127
OF ALUMINUM PRICES
AT THE LONDONMETAL EXCHANGE
(THREE
5.8. DEVELOPMENT
MONTH AVERAGEPRICE) 1988.1993 ..................................................................... 132
5.9.ALUMINUMEXPORTS
FROM FORMER
SOVIETUNIONCOUNTRIES
TO WESTERN
COUNTRIES 1989-1993.........................................................................................
133
5.10.A MODELOF THE BUSINESS CYCLEAND THE OFTIMUM TIMINGOF THE BARGAINING
PROCESS
AND DECISION-MAKING .........................................................................
136
PROCESS
BETWEEN THE ATLANTAL-GROUPAND THE ICELANDIC
5.11 . THE BARGAINING
GOVERNMENT
1987-1991. AND THE POSSIBILITY
OF FORGING
A BUSINESS
RELATIONSHIPIN THE FUTURE..............................................................................
137
xii
CHAPTER I
INTRODUCTION
During the nineteenth and twentieth century global economics have changed
dramatically. Technological changes, especially in communication and transportation, have
made the globe relatively 'smaller' in the sense that movement and integration across
space is faster and cheaper. Firms, especially big firms, now have wide ranging planning
horizons and capital is far more mobile than it once was. Recently the formation of large
economic units such as the European Union (EU) and the North American Free Trade
Agreement (NAFTA), have reduced political, economic, and social barriers of entry facing
investment and trade, thus hrther facilitating the mobility of firms.
Firms have used the increasing mobility of capital to expand operations and grow.
The operations of multinational corporations (MNCs) are now common in many countries.
The issue of foreign investment, however, is controversial from the point of view of
national development. Some countries see foreign investment by MNCs as a means to
economic prosperity, due to an, inflow of capital, job creation, expertise of one kind or
another, and increasing economic diversity. As a result there is often competition among
countries to attract potential foreign investors or MNCs. On the other hand, some
countries fear that foreign investment undermines national control over the economy,
truncates economic structures and in the long run results in large outflows of capital
(profits).
In deciding where to locate, MNCs do not simply choose from an existing bundle
of location characteristics, such as taxation, labour, and amenity, at different locations.
Countries, and locations within countries, certainly, differ in terms of location conditions
that are present. At the same time, location conditions can be developed and this
development is often subject to negotiation between firms, governments, and other
organizations. These negotiations, involve bargaining processes among the various
organizations, each of which seek advantages which to some extent are mutual and to
some extent are in conflict. This thesis offers a case study of foreign investment as a
bargaining process, involving the establishment of the aluminum industry in Iceland. In this
case study, the principal organizations engaged in the bargaining process are the MNCs
and the government of Iceland.
Location as Barpaininp Process
Within industrial geography industrial location has only rarely been interpreted
from the perspective of bargaining processes, with few exceptions, including Krumrne's
(1981) study of Volkswagen's entry into the U.S. Traditional 'descriptive' and theoretical
approaches emphasize spatial variations in cost and revenue conditions or factors as the
explanation for patterns of industrial location. Behavioural studies towards industrial
location, as exemplified by Stafford (1974) and Townroe (1969), interpret location from
the perspective of a decision-making process. However, this decision making process is
seen entirely from the perspective of the firm and the interests of other actors are either
ignored or relegated to minor consideration. Within the so-called 'geography of
enterprise' literature, there is explicit recognition that corporate priorities and preferences
may not be those of the region (Krumme, 1969; Hayter and Watts 1983). Even within this
tradition, however, there have been few detailed investigations of location as a bargaining
process between firms, governments, labour, and other institutions. Such a neglect is
surprising since to some extent location conditions and factors, both tangible and nontangible, are developed or 'constructed' by negotiations among different interest groups,
that is most location conditions are not fixed and they change through interactions of at
- least two parties. It is difficult to assess why this subject has been neglected by economic
geographers since it seems a logical development to how Krurnme (1969) defined the
geography of enterprise almost three decades ago. Two reasons can maybe explain this
neglect. First, in 'traditional' neoclassical approaches towards industrial location, which
remain important, firms are seen as abstract entities passively responding to economic
circumstances. Second, Mamist approaches, until recently, have interpreted 'capital' quite
broadly and have not focused on detailed interactions between individual firms and other
groups.
Two recent case studies within the geography of enterprise tradition which
analyzed industrial location from the perspective of bargaining process and with respect to
foreign investment are provided by Krurnrne (1981) and Soyez (1988). In addition, it
might be noted that Clark (1981, 1989) has examined the implications of labour relations the bargaining between management and labour
-
for industrial location. Interestingly,
none of these studies adopted an explicit model of the bargaining process. In political
science, however, models of bargaining processes have been developed and these models
recognize that bargaining is a complex process. According to the bargaining theories
developed in political science the outcome of a decision depends on which participant
needs the other more and the bargaining ability of each actor (see, for example, Keohane
and Nye 1989). In turn, the bargaining strength and ability of actors depends upon their
motivations and experience with related projects in the past. These models emphasize the
interactions among national governments and MNCs. Moreover, the literature recognizes
that over time, once an agreement is in place, bargaining relations between participants
may shift. Models of the bargaining process in political science also feature the location of
investment, most notably those developed by Contreras and Gregersen (1975) and
Goodman (1987). This thesis will seek to incorporate this literature within that of
industrial geography, specifically with regards to the location decision
In complex bargaining processes, such as those between MNCs and governments
over investment proposals, many issues are incorporated. In such cases it is generally
argued that MNCs focus mostly on economic factors and ultimately the profitability of a
project. The host country (HC), or in particular the host country government (HCG), in
their decision-making must include political and social factors as well. In this context, it is
necessary to make a distinction between the HC and HCG since the HCG need not
represent all interest groups in a country, for example, as might be expressed by unions,
environmental groups, opposition parties, and local governments. However, it is usually
appropriate to examine the bargaining process primarily from the HCG perspective for
three main reasons; the HCG is the most powerful organization in the country and has the
legal mandate to govern; the negotiators are representatives of the government; and the
HCG formally represents a nation in negotiations. In any case, it can be argued that the
process is far more complex from the perspective of the HCG than for the MNC. In their
studies of US investment in the forest industry in Latin America, for example Contreras
and Gregersen (1975) and Goodman (1987) created similar frameworks for analyzing the
bargaining process in which the HC was essentially represented by the HCG. In citing
these two studies it is possible to identi@ another gap in the literature as both frameworks
are constructed solely around interactions between MNCs and Third World countries.
As a multi-dimensional field of study, geography is well suitable for researching the
bargaining process. The geography of enterprise is well known and widely accepted
(Krurnrne, 1969; Hayter and Watts, 1983; Soyez, 1988) and an in-depth case study of
individual firms bargaining with a nation state can best suit the purpose of understanding
why the bargaining process is so important for both actors. For the enterprise, the
bargaining process affects location decision-making, the nature of location conditions, and
eventually the profitability of a project. For the HC, the bargaining process does not only
affect internal location conditions but also regional development and the fbture industrial
structure of the country. Such research should therefore contribute to the literature of the
'geography of enterprise'.
To explore these issues, this thesis will examine, in detail, the location choices of
particular MNCs as bargaining processes, with particular respect to the aluminum industry
in Iceland.
Iceland and the Aluminum Industry
The Icelandic aluminum industry provides an appropriate case study to examine
the bargaining process between MNCs and small countries for several reasons. First,
Iceland is a small country and the decisions of individual MNCs can have a big impact on
its development. Second, Iceland is a democracy; in fact, it has the world's oldest
parliament and is an example of a small country with long traditions of debate. Third, until
recently, because of its isolation, population, and geographical location, MNCs showed
little interest in locating there and while both Norwegian and Danish capital was involved
in the fishing industry until the 1920s, foreign investment from elsewhere was an unknown
phenomenon in the economic development of the country. However, in an effort to utilize
its resources, in the 1960s Iceland began to seek to attract foreign investment and MNCs,
especially in relation to power intensive industries. At this time, the aluminum industry
was prosperous and MNCs which were involved in that industry were expanding rapidly,
and were looking for suitable locations. As a result both the Icelandic government and
MNCs were interested in establishing an aluminum smelter, in Iceland, during the 1960s.
Because of its structure and characteristics the aluminum industry needs very
specific location conditions. Aluminum is produced in three different stages, mining,
smelting, and refining, and each stage has its specific needs. At the smelting stage (stage
2), in which alumina is reduced to aluminum requiring vast amounts of energy,
transportation is much less of a cost constraint than is availability of power. Of most
importance to primary aluminum producers is a location which has an energy surplus at a
low price. Iceland klfills this condition and therefore is a good locational 'candidate' for
the aluminum industry. In addition, Iceland offers other important secondary factors,
notably a stable political climate, labour (skilled and unskilled), good infrastructure and
transportation system, and closeness to markets. Evans (1993) adds that MNCs that locate
in Iceland and make agreements with the government can be certain that, though
governments come and go, agreements will always be honoured.
On May 5, 1961, the Minister of Industry (Bjarni Benidiktsson) organized a
committee, The Industrial Development Committee (TIDC). The task of TIDC was to
seek ways as to how Iceland could best use its energy resources, and what kind of power
intensive industry could be build in the country. TIDC invited specialists from two
Norwegian companies, Norsk Hydro and Elektrokemisk AIS, to come to Iceland. In a
report fiom these specialists they mentioned many possibilities for power intensive
industry, including a fertilizer plant, heavy water, and phosphor production but their
preferred option was for an aluminum smelter (Hafstein, 1965).
The first major foreign owned firm to enter Iceland was the Icelandic Aluminium
Co. Ltd. (ISAL), an aluminum producer owned by a Swiss MNC, Alusuisse. It built an
aluminum plant which started-up in 1969 (see chapter 4). In the late 1980s the Icelandic
government focus was again on the aluminum industry and the government started
negotiating with three major aluminum MNCs, Alumax from USA, Granges fiom Sweden
and Hoogovens fiom Holland, (the so-called ATLANTAL-group; originally the number of
firms involved were four) about building another aluminum plant in Iceland. This proposed
plant was supposed to be built in 1992, but construction was postponed until 1994.
Recently the group decided to postpone that plan for at least another 3-5 years. One
reason that has been mentioned to explain this delay is that Eastern European countries
have been selling relatively low priced aluminum, and as a result the ATLANTAL-group
has not been able to provide the capital to finance the project. Though the plant will not be
built in the near hture, the negotiations between the government and the ATLANTALgroup were mostly finished in November 1991, the only thing left was to sign the
agreement (see chapter 5).
Foreign investment has not only entered Iceland in relation to the aluminum
industry. Shortly after signing the Master Agreement with Alusuisse, the government
signed another Master Agreement (August 1966) with Manville Corporation International
to erect a diatomite processing factory, using deposits found at the bottom of Lake
M e a t n (Figure 1.1) (IBnaBarraBneytiB, 1986; 1988). In 1977, a third major MNC entered
the country, Elkem A/S of Norway which built a Ferro silicon smelter at Grundartangi
(Figure 1.1) (IdnaBarrabneytiB, 1986). Many other possibilities of power intensive
industries have been examined by the government in cooperation with MNCs, including
ferromangan production, titan sand production, and silicon metal, but none of them seem
economically justifiable. It should be added that both the diatomite factory and the Ferro
silicon smelter were jointly owned by the Icelandic government, which in both cases
owned the larger part of the shares, and MNCs. Iceland's law prevents foreign capital
from owning majority shares in Icelandic resource industries, especially those utilizing
renewable resources, such as fish and water. These laws do not affect the aluminum
industry because aluminum MNCs do not own or control any resources.
Today Iceland is going through the worst recession since the country gained
independence in 1944. Though unemployment reached 2% during the late 1960s (due to
the collapse of the herring stock) it has never gotten close to the 6% it has reached in
1994. During the late 1980s and beginning of the 1990s, in an attempt to fight back, the
country has been putting more effort in attracting MNCs to investing in Iceland. Though
foreign investment has not played a major role in the country's economic development, it
has been an important one.
Obiectives
This thesis explicitly interprets industrial location as a bargaining process. In
particular the central research theme of this thesis is to explain the actual and planned
investments in the aluminum industry in Iceland in terms of the negotiations that occurred
between the government of Iceland and MNCs operating in the aluminum industry. More
specifically, this thesis seeks to: 1) examine the bargaining process between the Icelandic
government and Alusuisse (1961-1966) that preceded the establishment of an aluminum
smelter in 1969; 2) examine the bargaining process between the Icelandic government and
Atlantic aluminum group (1987-1991) with respect to a planned aluminum smelter; and 3)
compare the different bargaining processes to asses how spin-offs from the first bargaining
process affected the second.
The underlying rationale is that location conditions are not provided by nature or
universal economic laws but are socially constructed by powerhl institutions, like
governments and big corporations. In order to understand the nature of location decisionmaking, its implication for local development, and the creation of location conditions it is
necessary to examine, in detail, the bargaining process that commonly precedes a foreign
investment.
Research Desipn
This thesis focuses on two case studies, namely, the negotiations between the
Icelandic government and Alusuisse between 1961- 1966, and the more recent negotiations
between the Icelandic government and the ATLANTAL-group (1987-1991). This case
study approach permits detailed investigation of complex processes which are vital to the
economic development of Iceland. In more general terms, this case study contributes
towards an understanding of the impacts of the behaviour of very large firms on small
countries while providing insight into the dynamics of industrial location. It also gives a
basis for comparison between the different cases.
The main information sources for the thesis are governmental documents and
papers, newspaper articles, and in-depth interviews with government and industry agents.
Due to a lapse of almost 30 years since the ending of the first bargaining process, it was
difficult to interview the people that took part in the first bargaining process, especially
Alusuisse managers. It was therefore necessary to depend more on newspaper articles and
governmental documents. Fortunately, the library at the Central Bank of Iceland had
gathered all documents, papers, letters and even notes, concerning the first case study, so
it was possible to reconstruct the bargaining process. Many of these sources were marked
'confidential', but as they are more than 25 years old they are now open to the public. At
the Alusuisse subsidiary, ISAL, people were more than willing to help. The same applies
to governmental workers and agents. Three open ended interviews were taken; two with
governmental agents, Johannes Nordal (Director of the Central Bank of Iceland (until
1993), Chairman of TIDC, and Chairman of the Board of the National Power Company
from its establishment in 1964) that participated in both negotiations, and Jon Sigurasson
(Pvl[lnisterof Industry from September 1988 to July 1993); and one from ISAL, Ragnar S.
Halldorsson (Director of ISAI, from 1969 and now Chairman of the Board).
For the second case study it was easier to access people that took part in the actual
bargaining process, and are still working towards reopening the negotiations and finish the
process, so a new aluminum smelter can be erected in Iceland.
Iceland
Iceland is a large island, 103,000 km2, located on the North Atlantic ridge in the
middle of the North Atlantic Ocean between Norway and Greenland (see Figure 1.1). The
population of the island is only 265,000 people. Reykjavik is the capital and 60% of the
population lives in the Greater Reykjavik area. The other 40% are spread around the
coastline mostly in small fishing villages, most of them with a population of 2,000 people
or less. The largest city outside the Greater Reykjavik area, Akureyri, is located on the
North coast, with almost 14,500 inhabitants. The harsh interior of the country has no
inhabitants.
Iceland became 'fbllvalda' (sovereign) in 1918 to the extent that the country
controlled all domestic matters but the Danish Crown still governed foreign policies. In
1944 Iceland gained fbll independence from Denmark that had ruled Iceland since 1262
(the country was first settled in 874). Iceland has the oldest parliament (Albingi) in the
world, established on Pingvellir in 930. Almost until World War I1 the country was a
farmer's society (sometimes referred to as a peasant society). However, this changed
rapidly during and after the war. Unbelievable economic growth changed the nation from a
peasant society to a developed nation over a short period of time.
Iceland is rich in two renewable resources, water (fresh and hot) in both qualitative
and quantitative senses, and fish (Rannsoknara6 Rikisins, 1975). Fish, fish products, and
agriculture have been the principal industries in Iceland over the centuries. In 1975 the
country was one of the first to extend its economic exclusive fishery limit to 200 miles.
This decision had a great effect on the country's economic status because in the mid-70s
fish products were around 90% of the country's export income. Since then this proportion
has dropped, to around 79.6% in 1993. Aluminum provides the second most important
source of export income, around 8.7% in 1993, while all kinds of other activities make up
the remaining 14.4%.
The industrial environment in Iceland has mostly evolved around the fishing
industry. As early as 1918 politicians pointed out that the nation should not only rely on
one source of export income but also it should try to diverse the industrial base (Hafstein,
1966b). A continuing emphasis in these pleas for diversification has the been suggestion to
utilize the energy resource (rivers and geothermal energy) in connection with different
kinds of industrial activities, especially power intensive industry.
It can be argued that the history of power intensive industry in Iceland began in
1953, when a small fertilizer plant was built near Reykjavik, and few years later a cement
production plant was built near Akranes (a small village 100 km from Reykjavik). Since
then the primary focus has been on the development of the aluminum industry.
Iceland is at a crossroad. Over the last few years there have been dramatic changes
in Europe. The European Free Trade Agreement (EFTA), in which Iceland has been a
member since 1970, will probably be dissolved soon because most of the countries that
were members of EFTA have applied for membership in the EU (except Iceland and
Switzerland). These changes will have great effect on Iceland's trade with European
countries, which are the largest consumers of Iceland's exports. Iceland has not applied
for membership in EU and that will probably not happen during the next few years,
because recently the former EFTA nations signed a business treaty with EU concerning
trade, to give EU time to evaluate applications from the former EFTA nations (Schram,
1992). Sooner or later Iceland will have to decide whether to stand outside the EU or not.
However, in the hture the nation will be able to evaluate how the EU has affected other
'neighboring' countries, for example Norway or Sweden, which are both former EFTA
nations.
Orpanization
This thesis is organized in six chapters. Chapter one, which presents the
introduction, outlines the thesis problem, the geography of Iceland and the aluminum
industry, the objectives and the research design of the study. Chapter two examines the
bargaining process. Here, concepts and frameworks are emphasized to explain the
bargaining process between HC(G)s and MNCs. The bargaining process is complicated
and can be as different as the number of countries and firms. At the end of the chapter is a
short discussion of the benefits and costs of MNCs to HCs. Chapter three is an
introduction to the aluminum industry. The focus is on the location economics, global
structure, and the characteristics of the industry. The importance of the bargaining process
for the aluminum industry is also noted. Chapters four and five present in detail the two
case studies. Both of these case studies deal with the aluminum industry in Iceland. First
the bargaining process between the Icelandic government and Alusuisse, that preceded the
establishment of an aluminum smelter in 1969, is traced. Then the bargaining process
between the Icelandic government and the ATLANTAL-group, that was ongoing between
1987-1991 in effort to establish another aluminum smelter, is examined. Chapter six
compares the two bargaining processes which includes a discussion of the 'spin-offs' from
the first process and how the latter affected the second, that is, how learning has affected
Iceland's bargaining strength since the last 30 years. At the end there is a short discussion
on the fbture aspects of foreign investment in Iceland.
CHAPTER I1
THE BARGAINING PROCESS BETWEEN
MULTINATIONAL CORPORATIONS AND HOST
NATIONS
Introduction
"Negotiation is a process through which two or more parties - be they individuals,
groups, or larger social units - interact in developing potential agreements to provide
guidance and regulation of their future behavior. Such negotiation is conducted not only
between nations, but also between government departments, political factions, labor and
management..." (Sawyer and Guetzkow, 1965, pp. 466).
This chapter reviews literature that discusses negotiations or bargaining between
nation states and multinational corporations (MNCs) that precede an investment. These
processes are clearly important since they determine whether or not foreign direct
investment takes place, and if it does, under what conditions benefits will be distributed
between participants.
There are two polar schools of thought regarding the local impacts of foreign
direct investment (Edgington, 1991). The 'pro-foreign investment school' pictures MNCs
as adding new resources to the host economy (e.g., capital, technology, management, and
marketing) in a way that improves efficiency and stimulates structural change. The
opposing 'dependencia' school asserts that MNCs will never bestow advantages on host
countries (HCs) because their power is essentially unconstrained and will always lie
outside the control of the state. Some argue, for example, that MNCs draw upon local
capital for their projects rather than bringing in new resources, use technology which is
inappropriate to the needs of the host economy and drive domestic producers out of the
market. Between these two polar views there is a third approach that recognizes that
investment repercussions are often complex and evolve in unforeseen ways and that, in
14
practice, both MNC strategies and local responses can change over time. As well as the
difference between particular countries in which MNCs are established, investment
outcomes have proven highly sensitive to difference between corporate strategies and
cultural background. The role taken by host country governments (HCGs) has been
equally important in shaping the course of corporate operations in their countries
(Edgington, 1991). Grieco (1985) calls this third approach the 'bargaining school'
-
.
approach. In this approach two themes dominate the understanding of relations between
(developing) countries and MNCs. First, bargaining school models emphasize the terms by
which an enterprise operates in a country and that the distribution of benefits between the
parties result from negotiations which are shaped by the balance of bargaining power and
abilities between the country and the company. Second, bargaining school models
emphasize that the balance of power and benefits between the MNC and the HC can
change over time (see Figure 2.5). In this respect, Grieco (1985) argues that the
developing country may control access to its markets and resources while the enterprise
has more important bargaining assets through its control of capital, technology and
managerial expertise. Over time, however:
". ..., according to the bargaining school, prolonged contacts with foreign enterprises
afford developing countries the experience needed to manage these relations more
effectively and to their greater benefit". (Grieco, 1985, pp. 56).
Supporters of this approach have tried to clarifjl what it is that MNCs and HCGs bring to
the bargaining table; how their relative strengths might shift over time; what will determine
the outcome of negotiations; how the benefits are likely to be divided; and what are the
most appropriate organizational responses by governments in their discussions with
foreign firms (Edgington, 1991).
This chapter reviews the bargaining school approach to foreign investment. The
review is organized according to three issues: the structure of bargaining situations; the
nature of the bargaining process; and changes in the bargaining process over time. By way
of introduction, the basis for the controversy over foreign investment will be briefly
reviewed.
The Controversy of Direct Foreign Investment
There are various 'immediate' reasons why firms invest in foreign countries. These
reasons can be to supply new markets with goods, to obtain cheap labour or resources in
the foreign country, or to hrther exploit technological advantages.
Watts (1987) argues that two phases can be discerned in the overseas operation of
firms, expansion and reorganization. He divides the expansion phase into two types:
market-led expansion and cost-led expansion. Cost-led expansion is mainly to reduce
variable cost, and according to Watts (1987) the key variable cost is labour. Market-led
expansion emphasizes the advantages of penetrating and producing in new markets. Firms
need to access more diversified markets especially if growth in the home market is not
permitted, for example, because of market saturation. The reorganization phase is a more
recent phenomenon. In this phase, because of cost pressures and for other reasons firms
integrate and reorganize their existing multinational production systems, including by
closing down operations in some locations. This pressure to reorganize has been hrther
stimulated as trade barriers between countries have been reduced and as larger economic
units, such as the EU, have become established.
The controversies over MNCs are deep and related to several issues. Thus views
differ as to whether MNCs expand national or local economies or exploit them; whether
they are either a dynamic force in economic development or a distorting influence;
whether they either create jobs or destroy them; or whether they either spread new
technology or pre-empt its wider use. The list of contrasting views is almost endless. All
aspects of the MNC operations - economic, political, and cultural, have been judged in
diametrically opposed ways by its proponents and its opponents.
Normally an immediate implication of foreign direct investment for a host economy
is an inflow of capital. This is not always the case since some new overseas ventures
undertaken by MNCs borrow capital on the HC's capital markets or they arise from the
reinvestment of retained earnings from the foreign affiliate. Moreover, local borrowing of
capital can have negative effects on local firms because they can be squeezed out of local
capital markets to the extent that the MNC is more attractive as a use for local savings.
Eventually there is a reversed flow of capital (given that an inflow of capital occurred in
the first place) from host to donor economy as the foreign firm sends earnings and profits
back to its parent company (or head office). Over time, this flow can exceed the inflow of
capital so the vital issue is the extent to which financial 'leakage' occurs from host
economies through the conduit of the MNC. MNCs may use transfer pricing, for example,
to avoid paying taxes. It is a problem, however, to assess the actual extent of transfer
pricing. The financial balance accruing (gain or loss) to the HC from MNCs not only
results from the effects of the net capital flows but also from any net earnings from trade.
Even so, as Edgington (1991) notes, MNCs are embraced by both developing and
developed countries as harbingers of growth and restructuring and, everywhere, there are
expectations that MNCs can play a key role in restoring economic activity, contributing to
development through transfer of technology, and by providing capital to relieve the burden
on commercial bank lending.
Two of the important questions surrounding the impact of MNCs on host
economies concerns their role in the HC's trade with the outside world, and the extent to
which they are integrated into the local economy through linkages with domestic firms.
MNCs affect the balance of payments of HCs through their control over the marketing and
purchasing practices of subsidiaries. If these subsidiaries, for example, import components
and parts from the parent company to a considerable degree then such behaviour can
result in a negative trade balance. On the other hand, a MNC may prefer to export
resources without adding value resulting in a positive trade balance while restricting
diversification possibilities. However, more significant in the long run, is the extent to
which MNCs are integrated into the national or local economy. The direct links with
indigenous firms are the most significant means by which technology is transferred,
additional employment created, and opportunities increased for the formation of new local
enterprises picken, 1992).
MNCs do not only invest in foreign countries to reduce costs, increase the rate of
return on fixed R & D investments, evade tariff barriers, and to ensure more uniform
quality and stability of operations but also to eliminate competition, tie up resources,
evade taxes, increase flexibility in responding to external demand, and simply to grow.
There are certain advantages to size (Hayter, 1981). Often the case is that foreign plants
are larger than their domestic competitors. This can both force domestic competitors out
of business and create new domestic enterprises. The major long term effect of the MNCs
entry is likely to be an increase in the level of industrial concentration in the HC (Watts,
1987).
For many observers, the most important issue in the debate over the MNC is its
effect on jobs. According to Dicken (1992) the most important factors are the volume of
employment, the type of employment, and wages. In this regard, Dicken (1992, pp. 402)
offers a simple formula to summarize the net employment (E) contribution of MNC to
host economy, namely, E = (DJ + IJ) - JD
where:
DJ= Number of direct jobs created in MNC
IJ =Number of indirect jobs in firms linked to MNC and in other sectors
JD= Number of jobs displaced in other firms
According to this formula MNCs may make a net positive or negative contribution to jobs
in a local economy.
There are also differing view points regarding the implications of MNCs for
competition and efficiency.There are two main viewpoints. The first viewpoint argues that
MNCs promote a more efficient distribution of resources since, by internalizing imperfect
markets, they are able to overcome distortions in the economic system, such as bamers to
the transfer of technology, tariff and non-tariff barriers and inappropriately valued
exchange rates. Their more efficient scanning and monitoring processes, and their
flexibility to respond better to market signals, is a usefbl competitive stimulus in a world of
uncertainty and information imperfection. The alternative viewpoint is that far from
overcoming market imperfections, the MNCs are themselves a major distorting force in
resource allocation, at least partly because of their ability to bypass market mechanisms
and/or government regulations. The result is that they engage in restrictive practices, raise
barriers to entry, and, by their internalization and centralization of decision-making,
adversely affect the efficiency of resource allocation between countries picken, 1992).
It is very difficult to calculate the actual costs to HCs arising from the activities of
MNCs. Truncation, is an umbrella concept that summarizes these costs. It means from the
perspective of the HC economy, less decision-making, fewer jobs for scientists and
professionals, fewer export opportunities in high value added manufactures, less discretion
over investment policies and increased dependency upon imported goods, services and
technology than might have been expected in the absence of foreign investment (Hayter,
1982).
Some nations also wish to avoid a high level of dependence on the MNC because
of the threat to national sovereignty and autonomy. Goals pursued by nation states and
MNCs are different and each is concerned to maximize its own welfare. If the HC's
economic activity is effectively controlled by foreign firms, non-national goals may
become dominant, a pattern which becomes more likely the more dependent the HC is to
MNCs (Dunning, 1981).
There are many reasons why the analysis of the benefits of a project as seen
through the eyes of a MNC may differ fiom the evaluation of a HCG. The benefits from
the viewpoint of the MNC are likely to be calculated in economic terms whereas the
government is likely to do its calculations in political and social terms as well (Vernon and
Wells, 1976).
In attempting to measure and evaluate the contribution of direct foreign investment
to an HC, Dunning (1981) claims that three important points arise which are not always
given the attention they warrant. First, the identification of the criteria by which the
contribution of direct foreign investment should be assessed is often unclear especially
given that the criteria, in the sense of what comprises a country's welfare, will vary
between countries, in the same country over time, and between different sectors within
any country. Second, Dunning (1981) notes that the difficulty in evaluating the effects of
direct foreign investment net of those effects that would have occurred if the resources
used by the investing companies had been differently deployed (see also Hayter, 1985).
The third and final methodological issue raised by Dunning (1981) concerns policy
prescription. Even if it is possible to measure the contribution of MNCs to employment in
a particular country, at least two questions arise: (1) is this the best possible contribution;
and (2) assuming it is, and it is beneficial, does this mean that inflow of direct foreign
investment should be encouraged? Whatever the answers, there is a great temptation
among policy makers to direct any change perceived necessary towards the MNC. For
example, if the balance of payment's contribution is negative, policy makers typically seek
to persuade MNCs to export more or import less, or, failing that, to reduce their capital
stake in the investment. In some cases, such policies may be the correct ones, particularly
where it can be established that the MNC is behaving in a less than optimum fashion.
However, in other cases it may not be so for example, because, there may be a trade-off
between achieving one national goal and another (Dunning, 1981).
Many other factors have influenced the internationalization of firms over the
century. New technologies in transportation and communication have shrunk the globe
and made it almost a single market area that is open to everybody who wants to sell,
produce or market a product, anywhere at any time. However, before entering another
country or another economic unit, there are frequently negotiations between at least two
participating actors, the HCG and the MNC. This process is known as the bargaining
process.
Models of the Bargaining: Process
The actual distribution of benefits and costs between MNCs and HCs depends on
the terms of an agreement that are, in turn, a function of the relative bargaining power and
ability of HCGs and MNCs (Kobrin, 1987). The key point for the HCGs is to try to recruit
those desirable production factors from foreign sources, for example, capital ifision,
technology transfer, foreign sales, while keeping out the undesirable ones, for example,
foreign management and ownership, competition against local producers, and threats to
HCGs political autonomy. On the other hand, MNCs would like to maximize their
ownership control, management flexibility, the protection of trade secrets, access to local
market, and favourable laws or administrative treatments regarding business tax, labour
relations, and profit repatriation. Conversely, the HCGs can be expected to try to
maximize their bargaining leverage to the extent that they possess important resources,
large consumer markets, strong social and industrial infrastructures, andfor geographic or
political proximity to the home governments of the MNCs (Chan and Mason, 1992).
A few models of bargaining between MNCs and HCs will now be reviewed. It
should be noted here that several of the models overlap and many originate from similar
sources. However, the discussion is organized to reflect different emphases in the
literature specifically the structure of the bargaining process, the nature of bargaining and
how bargaining evolves after investment.
The Structure of Bargaining Situations
In the literature that examines the structure of bargaining there is a 'smorgasbord'
of concepts which often overlap and are occasionally even contradictory. This section will
focus on several key concepts notably the relative bargaining strength and ability of actors;
the interdependence and asymmetry of actors; and the debate over relative bargaining
power of nation state vis-a-vis MNC. It should be noted that the literature, especially in
the discussion about interdependence, distinguishes interactions between: on one hand
government vis-a-vis government and on the other hand government vis-a-vis MNC.
However, this distinction is sometimes not clear as the literature in many cases overlaps.
Some time ago Hirschman (1945) argued that relative bargaining power is the
result of the relative evaluation of consequences and the relative value that bargainers
place on what is at stake in their negotiations. He illustrates his argument with reference to
the bargaining power of an entrepreneur in relation to the non unionized worker, typically
the former would not only enjoy advantages in bargaining skill, cunning, and information,
but would also derive bargaining strength from the fact that the worker 'needs' the
entrepreneur more than the entrepreneur 'needs' the worker. Thus, on the one hand,
relations between negotiators may be 'asymmetrical', that is, they have different degrees
of bargaining power in relation to each other, and, on the other hand, negotiators may
have different abilities (see also Wagner, 1988). Moreover, outcomes are not solely based
on bargaining power but also according to the 'bargaining ability' of each actor. Cross
(1965) adds that the concept of bargaining ability is vague and is primarily intended to
devolve the whole problem to psychologists, thus absolving economics of the guilt of
leaving the issue up in the air.
In the context of bargaining theory, the concept of 'interdependence' is crucial.
Coddington (1972) notes that before using bargaining theory it is necessary to distinguish
between two different types of interdependence. First, there is interdependence which is
recognized by the actors, and which they take account in their decision-making. Second,
there is interdependence which is unrecognized by the actors, and therefore not taken into
account in their decision-making. This means that if interdependence is not recognized by
a actor, he or she will make decisions in the 'false' belief that the other actor will make
decisions independently of his or her own. Decision-making of one actor is not
independent from the other's decision-making.
"The result, then, is that decisions made in the belief of independence, but on the basis of
expectations subject to adjustment in the light of experience, lead to a form of
interdependence unrecognized by the actors themselves7'.(Coddington, 1972, pp. 49).
In his study, Wagner (1988) uses 'asymmetrical interdependence' to explain how
bargaining theory can be used to explain economic interdependence and political
interdependence among nations:
( 1 ) I f asymmetrical interdependence means that one party to a mutually beneficial
economic relationship needs the benefits from it more than another, the asymmetrical
economic interdependence does not imply that the less dependent actor will be able to
exercise political influence over the other.
(2) fie use of economic interdependence for political influence requires, instead, that
the exchange of economic resources for political concessions make both parties to a
relationship better off than they would be if they bargained over the distribution of the
gains from the economic relationship alone. Whether this is true is entirely independent
of the degree of asymmetry in the economic relationship, or its direction.
( 3 ) If political concessions are expected as a result of a threat to interrupt an existing
economic relationship, this must be because there is unexploited bargainingpower in the
existing relationship, that is, the party demanding the political concession could, if it
chose, successfully demand morefavorable terms in the existing relationship.
(4) Even if there are unexploited bargaining gains in the existing economic relationship,
this need not be because there is asymmetrical interdependence, in the sense defined
above, since these unexploited bargaining gains may involve a subsidy of one party by
the other.
( 5 ) Thus, in the case of trade sanctions, the existence of unexploited bargaining gains
may be the result of the existence of unexploited market power. This is not necessary,
however, since they may be the result of an unrequited subsidy rather than of a failure to
exploit market power.
( 6 ) Even if there is unexploited bargaining power in an existing economic relationship,
there may be no way to convert it into political influence, since there may be no feasible
exchange of economic benefits for political concessions that is mutually beneficial.
(Wagner, 1988, pp. 481).
As can be seen from these arguments, Wagner (1988) shows that being less
dependent than one's partner is neither necessary nor sufficient to exercise influence in a
bilateral relationship. It is not necessary because a weaker actor with intense preferences
on one issue may make great concessions on other matters to attain its objectives.
Nevertheless, asymmetrical interdependence can still be a source of power in bilateral
relationships. Less dependent actors will be able to make bargaining concessions at lower
cost than more dependent actors. Furthermore, relationships between p o w e h l and weak
actors are often defined by multilateral rule or convention, without bilateral bargaining.
Under such conditions, strong states willing to break the rules or alter the conventions
may have unexploited bargaining power (Keohane and Nye, 1989; Wagner, 1988).
Keohane and Nye (1989) point out that to be able to understand the role of power
in interdependence, it is necessary to distinguish between two dimensions, 'sensitivity' and
'vulnerability'. Sensitivity involves degrees of responsiveness within a policy framework;
how quickly do changes in one country bring costly changes in another; and how great are
the costly effects? Vulnerability is particularly important for understanding the political
structure of interdependence relationships. In a sense, it focuses on which actors are 'the
definers of the, ceteris paribus, clause' and can set the rules of the game. Vulnerability
applies to sociopolitical as well as political-economic relationships. According to Keohane
and Nye (1989) the vulnerability of societies to transnational radical movements in the late
1960s depended on their abilities to adjust national policies to deal with the change and
reduce the costs of disruption.
Vulnerability is clearly more relevant than sensitivity, for example, two countries,
each importing 35% of their petroleum needs may seem equally sensitive to price rises; but
if one could shift to domestic sources at moderate cost, and the other had no such
alternative the second country would be more vulnerable than the first. The vulnerability
dimension of interdependence rests on the relative availability and costlines of the
alternatives that different actor's face (Keohane and Nye, 1989).
How does this distinction help us understand the relationship between
interdependence and power? Clearly, it indicates that sensitivity interdependence will be
less important than vulnerability interdependence in providing power resources to actors.
If one actor can reduce its costs by altering its policy, either domestically or
internationally, the sensitivity patterns will not be a good guide to understanding decisionmaking power (Keohane and Nye, 1989).
-- This
discussion about interdependence and bargaining has primarily drawn from
literature which has focused on nation to nation relationships. However, these arguments
can also be applied to interactions between the nation state vis-a-vis the MNC. For
example, Keohane and Nye's discussion about vulnerability of each actor is relevant in this
context to the extent that MNCs often have more power than the nation state as they 'set
the rules of the game' because often they have more alternatives in response to a given
change in the global environment.
Within the literature on the power struggle between the MNC and the nation state,
however, there are distinct and contradictory views. Kobrin (1987) argues that the relative
bargaining power of MNCs and HCGs is a hnction of three related elements (see Figure
2.5); first, the relative demand by each of the two participants for resources which the
other controls; second, the constraints on each that affect the translation of potential
bargaining power into control over outcomes; and finally the bargaining ability of the
participants. Figure 2.5 tends to suggest that HCs are subject to a greater variety of
constraints than are M K S , a reflection of the latter's greater potential flexibility in
negotiations. The extent to which a MNC can implement a globally integrated strategy is
constrained by nation state behaviour. Where a MNC particularly needs access to a given
location and where the HC does have leverage, then the bargain that is eventually struck
may involve the MNC in making concessions. It is in this kind of context that the HCYs
ability to impose performance requirements on foreign firms are greatest (Kobrin, 1987).
Galbraith (1983) states that the power struggle between the firm and the state has
changed considerably during the last century. During, what Galbraith calls, 'the age of the
organization' enterprises became powefil and were able to use their power to influence
the nation states and their governments.
"The corporation is a creature of the state...... As such, it enjoys full governmental
protection. Its power, including that of the international or multinational enterprise, is
also a source of worried comment and concern." (Galbraith, 1983, pp. 88).
Other researchers support this view (Harvey, 1982; Dugger, 1988; Peterson, 1988).
Peterson (1988) also argues that, from the perspective of the contemporary supranational
economy, there is an erosion of the power of the individual nation state to manage its own
economy.
"There is a sense of 'disenfranchisement' of 'national powerlessness' before the
behemoth that is the integrated world economy." (Peterson, 1988,pp. 159).
Zurawicki agrees and points out that in many negotiations the MNC is in a better
position than the HCG as it has far better knowledge of the nature of its activity and can
better anticipate the impact of these operations on the economy and its environment (see
Figure 2.5). That is why it is far easier for a MNC to convince the government in question
that the accepted terms are optimal. This is especially evident in developing countries
andlor where political conditions are not stable and where the learning process has been
short (Zurawicki, 1979). Krurnme (1981) adds that firms can be in a better bargaining
position as a result of competition between countries for investment. When MNCs decide
to invest in new facilities, countries may become rivals in attracting the firm and the MNC
has a fbrther possibility of waiting and then locating where the highest bidder is.
However, according to Galbraith (1983), nation states have been gaining in
relative bargaining power in relations to MNCs. The reason, he argues, lies in the
distinction between compensatory to conditioned power. Compensatory power refers to
power held by MNCs that operate in a clear monopoly. Conditioned power allows many
more interests access to the state, some of which are hostile to the MNC and thus
contribute to the adversary relationship, seeming or real, between MNC and modern
government. According to Galbraith (1983), throughout the 2 0 century
~
there has been a
shift from compensatory to conditioned power. Also, as Harvey (1982) points out the
nation state will always hold the power of setting laws and regulation concerning the
MNC, and will hold a considerable power when negotiating and contracting with such
enterprises. Kobrin (1987) adds that through development and transfers from foreign
investment the HC climbs up the so-called 'learning curve' and at the same time increases
its bargaining power as it gains technological and managerial skills, earlier possessed by
the MNC.
Peterson (1988), however, argues that individual nation states lose some of their
powers as a result of the creation of new institutional arrangements such as the EU which
comprise a collection of nation states. This view gains hrther credence given that after the
most recent changes in the EU there are almost no restrictions to the mobility of firms
which can make negotiations between MNCs and HCGs an obsolete phenomenon.
The Nature of the Bargaining Process between MNCs and HC(G)s
Most discussions of international business environments focus on how constraints
internal to the MNC and the HCG affect the nature of their objectives and how a given
benefit will be distributed among the parties involved. The objectives of other firms in the
international industry of which the MNC is a part can affect this division of benefits in a
decisive fashion. If the MNC and other firms have formed formal or informal cartels, the
MNC may be able to bargain with the HCG with the assurance that no competitor will put
in a rival bid for the arrangement under negotiation. If no such agreement exists, then the
HCG may try to solicit bids from a number of MNCs, thus increasing its bargaining
power. On the other hand, competition in some industries is rather tightly controlled by
relationships among the-- principal producers in that industry. In such cases of cooperation
and forbearance among competitors, the HCG may experience difficulties improving on
existing terms unless they can identifjl a firm that, for its own internal reasons, is willing to
break ranks (Goodman, 1987). Such was the case when Jamaica attempted to re-negotiate
the terms of its business relationships with international aluminum producers. Negotiations
were at a standstill until a relatively minor aluminum producer, Anaconda (a small
aluminum producer but a large copper producer), made an offer more favourable to
Jamaica than those offered by major producers (Litvak and Maule, 1975).
A business relationship can be forged and sustained only if a wide range of
considerations are taken into account and evaluated in terms of the opportunity in
question. In pursuing separate objectives, the actions of decision makers in MNCs and
HCs are conditioned by a wider context. This context affects both the total size of benefits
resulting from a given business relationship and how those benefits are divided. The
elements in this wider context are shown in Figure 2.1 (Goodman, 1987).
r--
objectives
>
Conditions in
international
Fl
objectives
>
MNC-HC
business
relationship
Objectives of
I competition I
13I
Figure 2.1. Factors Affecting a MNC-HC Business Relationship.
Source: Adapted fiom Goodman (1987), pp. 68.
Locating the firm's decision process within the broader context of a business
environment moves the discussion from how a decision is made by one party acting in
relative isolation to a much more complex setting. In pursuing their objectives, decision
makers in the firm respond to their own internal constraints (box 4, Figure 2. l), and they
also take into account the constraints and objectives of the HC in which they hope to do
business (box 5). In the final analysis, the MNC-HC business relationship (box 6) is shaped
by the objectives of the two parties involved. These objectives are, in turn, affected by the
objectives of other firms in the same industry as the MNC in question (box 3) and by the
concerns of the country in which the MNC's home office is located (box 2). All of these
are affected by other exogenous conditions in the international economic and political
systems (box 1) (Goodman, 1987; see also Krurnme, 1981).
Nixson (1988) argues that bargaining between the participating actors is the
process that in large part determines the extent, nature and distribution of the costs and
benefits that arise as a result of direct foreign investment. Figure 2.2 shows a simplified
model of the bargaining relationship between a MNC and an HC.
Rate of
Upper limit of bargaining
range for investment XA
Lower limit of bargaining
range for investment XA
I/
by
X
Maximum rate MNC can earn while host economy
is willing to admit XA amount of FDI
- - -
A
Direct investment
Figure 2.2. A Simplified Model of the Bargaining Relationship between a MNC and HC.
Source: Adapted from Nixson (1988), pp. 3 80.
In Figure 2.2 the bargaining range for a particular level of MNC investment (XA)
is shown to vary between: (1) lower limit (XY), that is the minimum rate of return that the
MNC is prepared to accept for the amount of investment XA; and (2) an upper limit (XZ),
that is determined by the cost to the host economy of either developing its own operation,
finding an alternative investor or managing without the particular advantages provided by
the MNC. XZ is the maximum return the MNC can make for the amount of direct
investment (XA) permitted by the host economy. It is in the interests of the MNC to try to
raise the upper limit (XZ); similarly, the greater the cost to the host economy of losing the
proposed direct foreign investment, the greater are the possibilities for the MNC of setting
the bargain near the maximum point (Nixson, 1988).
The bargaining strength or the bargaining power of each actor depends on the
relationships between the minimum requirements and motivations of the HC and the
MNC, as well as on the advantages (resources, services, and incentives) which each can
offer in terms of the other's objectives. In Contreras and Gregersen's (1975) framework
(Figure 2.3) two points are, to begin with, worth noting about the factors that motivate
both MNC and HCG and their relationship. First, some of the motivations of one party
may be complementary with those of the other party, while others may be competitive or
conflicting. Second, there are tradeoffs between different objectives or factors motivating
the HCG and MNC. Ultimately, it is the sum total of the interactions between these
factors that determines the relative bargaining position of each participant and the final
result of negotiations. It is a complex matter, partly because objectives and advantages are
not specifically described, and partly because the potential tradeoffs between any two sets
of advantages are difficult to predict quantitatively (Contreras and Gregersen, 1975).
Goodman (1987) uses almost the same framework as Contreras and Gregersen
(1975) (Figure 2.4) in his study, which is perhaps not surprising because both Goodmann
(1987) and Contreras and Gregersen (1975) studies are conducted in the same industrial
sector in Latin America.
According to Contreras and Gregersen (1975), both MNC and HCG have certain
minimum requirements that have to be met. For the HCG, those requirements may be
expressed as laws or guidelines while some corporate investors tend to have certain
guidelines for minimum profitability requirements and ownership shares. A problem can
occur if the minimum requirement of one party is in direct conflict with the other's
minimum requirement. If either party does not relax their requirements the project has to
be abandoned. Another reason for abandoning the project is if particular physical,
technical or economic characteristics are such that one or more of the requirements cannot
be met. In other situations, the minimum requirements of both the HCG and the MNC can
evolve or change through discussions and can therefore lead to negotiations. This
development leads to a different situation, the so-called 'negotiable situation'. The final
settlement in this case depends on negotiation or bargaining. The final situation is called
the complementary situation. This stage exists where both parties have complementary
objectives and minimum requirements of both parties merely reinforce each other
(Contreras and Gregersen, 1975).
The various factors determining minimum requirements are shown in Figure 2.3.
According to Contreras and Gregersen (1975) there are three main factors that determine
minimum requirements for the MNC. First, internal conditions in the MNC, for example,
in management objectives and profit position; second, home country conditions, for
example, markets, and laws; and finally, relevant issues in the rest of the world, for
example, other investment opportunities determine changes in company policies and
minimum acceptable conditions. Also according to Contreras and Gregersen (1975), there
are three main factors that determine minimum requirements for the HC. First, internal
HCG policy conditions, for example, changes in government and political motivations;
second, other conditions in the HC for example, resource availability and markets; and
finally, conditions in the rest of the world determine HCG policies and minimum
acceptable conditions for accepting foreign investment. These conditions then provide the
context within which the MNC and HC set their objectives and develop their motivations
which in turn determines the type of interaction situation which arises in any given case
(see Figure 2.3).
e
Exogenous
conditions
in home
country
and
rest of the
world
MNC objectives:
Profits
Market maintenance or
expansion
Raw material supply
HC objectives:
Income growth
Foreign exchange earnings
Employment
'Development'
:xogenous
onditions
n HC and
n rest of the
vorld
II
-4
.L
Factors motivating MNC:
Availability of low-cost
inputs
New markets
Government stability and
support
Other factors affecting
cost
Factors motivating HC:
Access to capital
Access to technology
Access to markets
Access to organizational
and managerial expertise
Increased government
revenue
Increased employment,
value added, etc.
minimum
requirements
Internal
HC policy
conditions
1 Fl
ments
J
.
L
Interaction between HC and MNC
I
I
Conflict in motivation
No conflict in motivation
I
I
I
I
I
I
I
'Negotiable'
situation
conflicts
1
situation
Adjustment
Negotiation and
No negotiation needed:
Tndeoffs not possible
negotiable elements
I
II
I
No investment
n
,
Total benefits positive:
Distribution between HC
and MNC depends on
relative bargaining strength
> - I
Feedback
maximized
L
takes place
I
L - - - - - - - - - - - - - - - - - - - - - - - d
Figure 2.3. Summary Model Describing the Interaction between MNC and HC for a Given
Investment Proposal. Source: Adapted from Contreras and Gregersen, 1975, pp. 49 & 51.
MNC objectives:
HC objectives:
1. Achive earnings, market
share, andlor supply goals
2. Freedom to manage
3. Visibility of subsidary
inside MNC
MNC criteria:
1. Economic development
2. Increased employment
3. Balance of payment
benefits
HC criteria:
1. Law factor of production cost
New market penetration
Satisfactory earnings
Government support
2. Low use of executive time
Little 'red tape'
Few management alternatives
precluded
3. Subsidiary growth at rate
comparable or superior to
rival units in MNC
1. Service to domestic market
Links to rest of economy
Growth of domestic capital
Government revenue
2. Increased employment and
value added
3. Availability and low cost of
capital, technology, export
markets, and managerial skill
I
Negotiation
of details
Negotiation concludes
with benefits distributed
as a function of relative
MNC-HCbargaining
Figure 2.4. Interaction between a MNC and a HC about a Possible Business Relationship.
Source: Adapted from Goodman (1987), pp. 75.
Despite constraints imposed by the international economic and political systems,
home countries of MNCs, and other members of the international oligopoly of which the
MNC is a part, the possibility of forging a business relationship are, in the end, feasible
only when there is a minimum of mutual interest and compatibility of objectives between
the MNC and the HCG. Figure 2.3 shows the whole framework of the bargaining process
which HCG and MNCs attempt to forge business relationships once their individual
objectives have been specified (Contreras and Gregersen, 1975). Objectives, initially
phrased broadly, can be specified in terms of more specific criteria by both parties and, as
MNC-HCG interaction proceeds, are eventually stated in terms specific to the relationship
at hand. For example, specific tariff levels or tariff exemptions can be stated for inputs to a
manufacturing process; exemptions from certain taxes and import restrictions can be
negotiated. A specific minimum of the value added resulting from domestic labour can be
required, thus aiding the host's balance of payments, ensuring local jobs and/or the
development of local ancillary industries. Intracorporate loan interest rates, royalty
payment levels, management, and sales and service contracts can all be determined
through negotiation at levels mutually acceptable to both parties (Contreras and
Gregersen, 1975; Goodman, 1987).
Normally, a business relationship is not worked out overnight, although there have
been projects of such obvious mutual interest that have been negotiated rapidly. However,
it is not feasible to explore every issue in its entirety when working out a agreement. It is
not feasible because all information can never be collected and impractical because
executive time is an especially scarce commodity for both firms and nations. At some point
in negotiations, the costs of continuing to use scarce executive time and tolerate start-up
delays may exceed gains resulting from complex bargaining. However, a potential project
may be dropped quickly by one or both parties (Goodman, 1987). In this regard,
Contreras and Gregersen (1975) point out that the main causes of failure among the
projects they studied were change in governmental policy or uncertainty with regard to
fbture policies; inadequate information on resources; technical problems which raised
costs; market problems; change in company policy; lack of adequate government support
in providing infi-astmcture and technical services, which were agreed upon; and lack of
MNC control of interest. In sum, it appears that the same factors that are important in
explaining failure or abandonment of projects and the lack of new investment. The main
factors include extent of government stability and support, change in HC conditions, and
amount and quality of information available on resources, costs, market conditions and
profitability prospects. In addition, failures and abandoned projects are associated with
internal changes in the investing corporations and lack of sufficient interest and control on
the part of the parent company (Contreras and Gregersen, 1975).
The Bargaining Process after Investment
Since World War I1 HCGs have been rapidly improving their ability to evaluate
and monitor business relationships. The same has been true of MNCs, although, for the
most part, they have possessed more highly developed skills for a longer period of time
(Goodman, 1987). However, bargaining between MNCs and HCGs is complex and this
complexity partly results from the attempt to take into account as many factors as possible
when working out a business arrangement. According to Goodman (1987) there is a
strong pressure from both sides to include every little detail in negotiations which
increases the complexity. Despite this strong pressure for increasing complexity, counter
pressures for simplicity, from both the HCG and the MNC, also exist. These counter
pressures exist because; scarce executive time in both firms and nations is consumed by
complex bargaining; and while often suggesting new areas for negotiations, learning can
also lead to devices that simplify bargaining (Goodman, 1987).
"Bargaining between firms and nations goes on, spawning business arrangements of
varying complexity. These arrangements are negotiated, however, in continuaIIy
changing environment that is altered by bothforces external to the firm-state bargaining
process and by forces intrinsic to it. Although it is difficult to speczfi aspects of
environments exclusively affected by bargaining, it is possible to indicate a variety of
circumstances in which new phenomena have been created, at least in part, as a result of
newly complex firm-state bargaining. For the sake of crispness, let us refer to these new
circumstances as spin-offs, since they exist side by side with the bargaining process.
Spin-offs have resultedfrom two aspects of the bargaining process; (I) the learning that
both parties have experienced over time, and (2) the outcomes of the bargaining."
(Goodman, 1987, pp. 133-134).
Spin-offsfrom Learning
Both firms and HCs as well as donor countries and other interested observers have had the
opportunity to derive lessons from firm-nation state bargaining and to mod@ future
practice and policy in the light of this experience. This learning has resulted in a number of
new developments, among them new goals for both firms and nations, new forms of doing
international business, new division of activities between firms and nations, new guidelines
for links between politics and business, new institutions especially created to service
situations resulting from the complexity of firm-nation state bargaining, and new forms of
legislation for international business, enacted by both the host and home countries of
MNCs (Goodman, 1987).
Spin-offsfrom Bargaining
The results of MNC-HCG bargaining have themselves caused changes in international
business and politics. These changes are only beginning to be recognized because many
Third World nations have just begun pursuing development objectives that are both
nationalistic and comprehensive. Furthermore, the uproar surrounding certain bargaining
situations, especially those involving the nationalization during the 1970s of raw material
properties owned by MNCs, has sometimes seriously clouded understanding. There are
three areas in which spin-offs from the bargaining process are currently visible; first, the
way in which bargaining between MNCs and HCs now takes place; second, the emergence
of a new pattern of international stratification that corresponds to outcomes of the
bargaining process; and finally, the evolution of an international order based less on
economic or political principles than commonalties of objective economic and political
interests (Goodman, 1987).
According to Kobrin (1987) much of the literature on bargaining focuses on
vertically integrated, extractive investments characterized by risk, sunk costs, government
learning, and oligopolistic rivalry. In the natural resource industries, there is strong
evidence that; outcomes are a hnction of relative bargaining power; and it has been
suggested that from the MNC point of view, the bargain obsolesces over time as power
shifts to developing HCs (see Figure 2.5) (Kobrin, 1987).
Obsolescing Bargaining
There may have been a time in international affairs when foreign producers of raw
materials anticipated that a bargain with a HCG, once made, would not come unstuck.
The opposite is generally assumed today. The assumption derives in part from an
increasing appreciation of the process that leads governments repeatedly, almost
predictably, to reopen the issues involved in the exploitation of raw materials or other
resources (Vernon, 1971).
In most cases when a MNC enters another country, the event is generally
celebrated by the signing of some sort of contract (Master Agreement) between the MNC
and the HCG. This contract or the bargain is quite formal in character, and usually
includes a series of commitments on the part of both parties. For example, the MNC may
not be able to engage in certain stated programs or projects while it may be required to
train and provide social service for its labour force. The government, on the other hand,
may not be allowed to, for example, tax the MNC beyond certain levels. These contracts
maybe long term, thirty years or longer is common. Yet, almost fiom the moment that the
signatures have dried on the document, powerful forces go to work that quickly render the
agreements obsolete in the eyes of the government (Vernon, 1971; 1980).
Host Country
Multinational Corporations
I
I
I
Power resources
Power resources
Constraints
Thechnological
complexity, intensity,
rate of change
Degree of
competition and
concentration
in the industry
Managerial
complexity
Capital
I
I
I
legotiating
bility of
INC and
IC
>
Access to markets
or export potential
Extent to which
HC government
is important
customer or
distributor
Advertising intensity
and product
differentation
,
Employment
f
Access to the
domestic market
Degree of global
n t e p t i o n in
h e industry
Control of
natural resources
Availability of
appropriate labour
Degree of
:ompetition amon:
zountries for
the investment
Availability of
suitable
infrastructure
Balance of
pay ments or
dept problems
Political climate
Dependence of the
economy on FDI
I
I Government
I
L
incentives
Change over time in relative bargaining strength
Relative power of MNC
vis-a-vis HC increases
Constraints
Political instabilitj
or uncertanity
>
Relative power of HC
vis-a-vis MNC increases
Figure 2.5. Components of the Bargaining Relationship between MNC and HC.
Source. Adapted from Kobrin (1987), pp. 628.
Vernon (197 1) explains:
"Asforeign .... operations become more and more integrated in the economic life of host
countries - through increasing payments to government and the increasing use of local
labour, materials, and resources - the vulnerability of the economy to changes in these
operations inevitably seems to increase. i%e obscure questions of law, the complex issues
of fact, and the generous outpourings of ideology that have been injected into the
disputes on these occasions have not masked the prime fact - that the sense of
dependence that host governments experienced was at times beyond bearing." (Vernon,
1971, pp. 52).
These factors are sufficient to explain the sources of tension and unhappiness on the part
of HCG. However, there is one other factor that should also be taken into consideration
and that is political stability. Governmental changes can alter the bargaining process or
even the contract as a whole, especially in developing countries where revolutionary
events more often occur (Vernon, 1971).
Because the agreement can grow obsolete quickly the agreement should be open
to changes after certain time. Both sides are aware of the fact that in the majority of cases
the terms of the agreement reflect the actual bargaining power of the two parties and
consequently these arrangements must be changed at a time when these relations assume a
different nature. Thus, it would be most appropriate to make reservations in the first
contract that certain terms are subjected to alteration within a definite period of time. The
length of this period may become a subject of negotiations and, on the one hand, for the
sake of stability, it cannot be too short, on the other hand neither can it be too long if
sudden changes are to be avoided (Zurawicki, 1979).
Vernon (1985) argues that one of the factors that explain the attack and threats to
MNCs during the 1970s, was the inexorable operation of the obsolescing bargain. As
shortages appeared in various raw materials, MNCs lost the bargaining power that their
marketing capabilities normally afforded. From time to time, in the fbture as in the past,
when that happens, some of those enterprises will be nationalized, joining the plantations,
40
the power plants and the oil wells that have been taken over by governments in years past
(Vernon, 1985).
"But the future is no simple extrapolation of the past. Some forces seem to be speeding
up the process by which the bargain between governments and foreign investors becomes
obsolescent. At the same time, other forces seem to be d~flusingand defising the
underlying hostility that gives the process of the obsolescing bargain some of its motive
force.
The expectation that agreements between governments and investors will be
breached even more quickly in the fiture than in the past is based on various factors. In
reappraising their bargaining positions, governments are better informed and better
equipped than they have ever been. Perhaps more to the point, opposition forces that are
bent on embarrassing their governments have more information and more
expertise.........., individual multinationals have nothing like the bargaining position they
sometimes held in the past.
Yet governments seem constrained to use their increased bargaining power in
more ambiguous ways. Instead of outright nationalization, they seem disposed to settle
for other arrangements, such as arrangements that make a gift of some of the equity to
favored members of the local private sector or to an expanding state-owned enterprise,
or contracts that allow the MNC 's to manage their properties without formal ownership."
(Vernon, 1985, pp. 257-258).
Summary
As can be seen from the above discussion, the bargaining process is complicated.
Contreras and Gregersen's (1975) framework of the bargaining process (see Figure 2.3)
provides a reasonably comprehensive picture of interactions between HCGs and MNCs,
and it is a useful framework in which to analyze the bargaining process between the
Icelandic government and aluminum MNCs. However, bearing in mind that Contreras and
Gregersen's (1975) framework was structured on the basis of research of foreign
investment in the forest industry in Latin America, it is impossible to apply their
framework without any adjustments. There are three main reasons why the framework has
to be adjusted to the topic of this thesis. First, the framework does not give any specific
reference to location which is of main concern in this thesis and, in relation to location,
41
there is little discussion about regional development and the environment. Second,
important issues are not the same for the aluminum industry as for the forest industry.
Third, the research area (Iceland) in this thesis is not comparable to Latin America in
terms of size, situation, and stage of development. Because of these constraints it is
impossible to structure the case studies directly after this framework.
Moreover, Contreras and Gregersen's (1975) framework does not incorporate all
the important issues that affect negotiations between a HCG and a MNC. In particular,
concepts such as 'bargaining power' and 'bargaining ability' are important and need to be
included. The bargaining power and ability of each actor have to be examined and how
they affect the outcome of the negotiations. In addition, spin-offs, learning, and the
obsolescing bargaining have direct impact on negotiations and how the bargaining process
evolves. These concepts will be examined and how they affected the negotiations between
the Icelandic government and aluminum MNCs.
Before turning to the actual case studies of this thesis, the next chapter gives
-
background on the aluminum industry and outlines the relevant aspects of the bargaining
structure among governments and firms.
CHAPTER I11
GLOBAL DEVELOPMENT OF THE ALUMINUM
INDUSTRY
Introduction
"...withinthe lifetime of many people now living, aluminum has gradually penetrated the
consciousness of industrial societies. If steel was the workhorse of the industrial
revolution, the light metal has been the queen of a newer technology. Aluminum has
bridged the gap from railroah to rocket ships." (Brubaker, 1967, pp. 3).
The purpose of this chapter is to outline the evolution and characteristics of the
aluminum industry, specifically since World War 11. In particular, the chapter focuses on
the locational economics or requirements of the smelting stage of the industry. As part of
the discussion the chapter will strengthen the ties between the framework of the
bargaining process and the aluminum industry and note the nature and extent to which
bargaining among firm and between firms and governments is important to the aluminum
industry.
As can be seen from Brubaker's (1967) quote aluminum is known today as a
relatively 'young' metal. Although aluminum was not separated as a metal until 1825,
various bauxite-type silicates were treated as early as 5300 BC in Northern Iraq for
making pottery. Exposing various clays to the hot sun or placing them next to a fire would
eventually make them as hard as stone (Banks, 1979).
The primary aluminum industry comprises three different stages; mining, smelting,
and -refining. First, bauxite is mined fiom ore deposits and converted into alumina by the
Bayer process. The Bayer process treats bauxite chemically by removing impurities and
water to form 'aluminum oxide' or alumina. Then alumina is converted into primary
aluminum by the so-called 'reduction' process using the Hall-Heroult electrolysis process.
This process requires copious amounts of electrical power to create a strong electrical
current to liberate oxygen from a molten bath of alumina. This process was developed in
1886 (Woods and Burrows, 1980; Holloway, 1988; Peck, 1988; Banks, 1979). On
average, the production of 2 kg of alumina requires 4-6 kg of bauxite. Similarly, a typical
Hall Heroult process requires 2 kg of alumina to produce 1 kg of aluminum (Banks,
1979). The third stage in the primary manufacturing process involves the conversion of
aluminum ingots into (one of the following) foil rolling, rolling, extrusion, forging andlor
casting (Peck, 1988; Holloway, 1988). Once in one of these stages aluminum is either
converted into a wide variety of consumer products (e.g. pots and pans) or used to
fabricate components for an assembly line product (such as airplanes). In addition
aluminum finds its way into paints, pharmaceuticals, and even fibers in gowns (Holloway,
1988).
As mentioned above this chapter will specifically focus on the second stage, the
reduction process or aluminum smelting.
The Global Production of Aluminum
During World War II the potential for an aluminum crisis developed because of the
greatly increased demand for aluminum and uncertainty as to whether the supply would be
able to expand rapidly enough to avoid a serious shortage. However, a rapid production
increase prevented any major crisis (Woods and Burrows, 1980). The increase in
production did not slow down after the war (see Figure 3.1). As an example, while steel
production expanded at roughly the rate of GNP increase, aluminum grew three times as
fast in the decade following World War 11. Much of this expanded consumption can be
explained in terms of the unique properties of the metal, related to its light weight,
corrosion resistance, electrical conductivity, and non-toxicity. Aluminum has one-third the
-
weight of copper, brass or steel. Because of these characteristics, aluminum is ideal for
aviation and other transportation uses. Expansion in aircraft output alone explains much of
the dramatic increase in production. With respect to corrosion, unlike iron and steel,
aluminum is not afflicted by rust, thus opening up nautical and architectural uses. These
first two properties lead to uses in the manufacturing of light boats, ladders, and other
utilities. The military has long been a major consumer which explains major production
expansions during the wars of this century. Aluminum has twice the conductivity on a
pound by pound basis (but not volume) of copper. This property results in the use of
aluminum long distance transmission lines. Finally, aluminum gives off no toxic chemicals
leading to numerous cooking and packaging applications such as aluminum cans, pots and
pans, bottle caps and foil (Holloway, 1988).
As can be seen from Figure 3.1 there has been a tremendous increase in the
production of aluminum ingots during the last few decades. Technological innovations in
producing aluminum do not explain this rapid production increase. The basic Hall-Heroult
process is still used though it has been improved often during this century. Figure 3.1 also
shows that production has never exceeded consumption during the last four decades.
Instead, at times, demand, has exceeded the supply, though the industry has never faced
any crisis. This situation, however, has changed during the first half of the 1990s as
production has far exceeded consumption. This situation also explains the crash in the
price of aluminum in recent years (Figure 3.2). Price trends hrther reveal the 'stable life'
of the industry fiom World War I1 until early 1970s and the more recent 'turbulent life'
since then. The most recent changes, towards more volatile production and price
behaviour, are due to increasing exports of cheap aluminum fiom Eastern Europe,
especially from Russia, to Western countries. However, there are some indications that
this trend is coming to an end. Russia, which had stockpiled huge amounts of aluminum in
case of warfare, has been selling its stocks. The country has also decided to cut production
during 1994, due to low price on aluminum (MorgunblabiiS, 1994a).
Aluminum ingots
World production
World consumption
+*
1950
1955
1960
1%5
1970
1975
1980
1985
1990
Year
Figure 3.1. Production and Consumption of Aluminum Ingots 1950-1990.
Source: Adapted from ABMS (1955; 1961; 1967; 1972; 1977; 1982; 1987; 1991).
Another indicator is that bauxite production in Eastern Europe has dropped from 6.3
-
million tones in 1988 to 3.2 million tones in 1991. The reason is that most mines in the
region are small in size and mining conditions are among the most unfavourable in the
world. So far, the use of poor equipment combined with labour-intensive methods, low
real wages and very cheap power (4-9 mills per Kwh), have allowed many operations to
continue. This situation cannot continue for long, and as a result production will have to
be reduced. Another problem for the industry is that the Eastern European bauxite is of
poor quality, and as the market demands better quality aluminum it will be difficult for
Eastern European countries to compete (Bomsel and Hirschhausen, 1992).
-
I
1
1
I
1
I
I
I
I
I
I
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
Year
Figure 3.2. Unadjusted Price of Primary Aluminum 1945-1993.
Source: Adapted from U.N. (198 1); Peck (1988); Palsson (1 993); ABMS, (1990).
The global production of aluminum is closely tied to the specific location
requirements that the industry needs. The most important locational characteristic that the
industry needs is electrical power. Electricity is required in such large amounts, in the
smelting of alumina, that it becomes a major component of cost and it is a cost that varies
considerably among locations. It is usually the second largest item in terms of cost
(alumina ranks first) but the most important locational cost. This makes it very important
for aluminum firms to locate where there is abundance of low-priced power (Holloway,
1988; Brubaker, 1967; Peck, 1988). The industry is also capital intensive and exhibits
considerable economies of scale so that large-scale processing occurs at all stages,
although especially with respect to bauxite refining. Other stages, such as the reduction
stage, have favoured at least 200,000 ton annual capacity since the 1980s. In fact, the
aluminum industry is more capital-intensive industry than steel making (Brubaker, 1967;
Holloway, 1988). Even at full operation capital costs are an unusually large share of total
costs. Capital intensiveness, combined with advantages to scale, means that large
investments are required and therefore investors favour politically secure locations for
such expensive facilities (Brubaker, 1967). Other characteristics do not have as much to
do with location except for transportation. However, the cost of transportation is only a
fraction of the total cost of smelting and does not put any constraints on where aluminum
smelters are built. Hence a typical European aluminum MNC mines in Africa (the refining
of alumina is usually operated where the bauxite is located to reduce transportation costs),
reduces in Norway (or where there is a cheep source of electricity), and fabricates in
central Europe close to its major markets (Holloway, 1988; Brubaker, 1967). Table 3.1
shows the global distribution of production of aluminum ingots in 1970 and 1990.
TABLE 3.1
WORLD TRENDS INPRODUCTION OF AL1970
IGNOTS 1970 AND 1990.
1990
in 000 of short ton
U.S.A.
Canada
S-~rnerical
Europe
(Iceland)
3,976.1
1,061.0
181.5
2,226.4
4,462.5
1,727.8
1,969.1
4,739.3
(25.0)
(85.0)
2,146.22
Russia
1,015.0
Asia
182.3
Africa
Oceania
226.6
1. Including Mexico
2. Conjectural. All communist countries including China.
Source. Adapted from ABMS (1972; 1992).
2,425.1
2,218.7
662.6
1.645.1
Or~anizationalstructure of the aluminum industry
"Any industry's behaviour depenh primarily on such aspects of its structure as the
degree of concentration, the height of barriers of entry, the degree of product
differentiation, the extent of vertical integration, the nature of channels of distribution,
the rate of growth and stability of demand, and government intervention and regulation."
(Woods and Burrows, 1980, pp. 11).
The present organization of the aluminum industry, since its establishment as an
industry in 1886, reflects a long process of evolution from small, localized operations to a
complex, international industry. Before World War I1 the aluminum market was too small
to support more than a few efficient size firms. Since then the aluminum market has
become increasingly international in character as a result of the multinational operations of
the principal aluminum firms, the declining importance of transportation cost, and the
widespread location of bauxite deposits, alumina, and smelter capacity (Woods and
Burrows, 1980).
Vertical integration is an important factor in the organizational structure of the
industry (Woods and Burrows, 1980). To be competitive in the industry, firms have to
engage in all aspects of the production, including the three production stages. Peck (1961)
concluded that vertical integration as a structural feature of the industry is an important
entry barrier, for new firms, into the industry and is at least a partial explanation of why
the industry is so highly concentrated. It has also been established that the industry has
other basic structural features that promote vertical integration. According to Peck
(1961), briefly, the argument is that bauxite mining, alumina refining, and primary smelting
each has structural features that even without vertical integration would produce moderate
to high firm concentration at each stage. Each vertical pairing of the three technically
linked stages could confront problems at any other stage, according to how symmetrically
market power is distributed at each production stage. On the one hand, symmetrical
market power is a likely event in the bauxite market, but on the other hand, asymmetrical
market power leads to the exploitation of the weaker stage by the stronger stage, a likely
event in the alumina market and a problem for primary aluminum producers. Though this
is only an example of how market power can affect the industry this can pose a problem to
firms that are not integrated into all production stages.
Vertical integration is only one of a few entry bamers into the industry. Most
production stages favour large scale production, leading to considerable economies of
scale. These economies of scale make the aluminum industry- a very capital intensive
industry, even more so than the steel industry. This capital intensiveness fhrther promotes
entry barriers, thus leading to moderate or high levels of firm concentration (see Table
3.2). In fact, apart from brief periods of state regulation during World War 11, the
aluminum industry has long exhibited high levels of corporate concentration and it has
been characterized by the growth of few firms, notably the six majors. These six leading
firms are Aluminum Company of America (Alcoa), Alcan Aluminum Limited (Alcan),
Reynolds Metals Company, Kaiser Aluminum and Chemical Corporation, Compagnie
Pechiney, and Schweizerische Aluminium A.G. (Alusuisse) (Woods and Burrows, 1980;
Graham, 1982; Peck, 1988; Brubaker, 1967; Stuckey, 1983). Table 3.2 shows the shares
of industry, for all three stages of production, for these six major aluminum firms,
presented at four equidistant points in time over the 25 year period of 1955-1979. As can
be seen from this table the majors have dominated all three production stages since World
War I1 though their ratio of world production has been lowering. This trend has
continued. Alcan and Alcoa are still the leading firms in all stages of the aluminum
industry, but their share, and the share of the others, has declined considerably. In 1987
Alcan produced a little over 10% of primary aluminum in the world and in 1993 Alusuisse
produced just over 1%. Similar trends can be noticed at other production stages. The
reason for this trend is that these firms have diversified their operations and other large
corporations have emerged into the market and others have expanded their operation, for
example, AMAX an old American based firm (see Table 5.2).
At this level of concentration, the theory and evidence for oligopolistic markets
implies that mutual dependence would be recognized and that firms in each stage of the
industry would attempt to 'gang up on' and extract rents from their mutual suppliers,
customers, or both (Stuckey, 1983). Because the firms are few and vertically integrated
they can work together, for example, to force aluminum prices up or lower the cost of raw
materials. The industry's development has also been marked by substantial government
support, both financially in the form of loans, subsidies, tariff protection and concessions,
and politically in the form of military expenditures, stockpiling, and diplomatic pressure.
This stockpiling, especially in the case of warfare, explains why aluminum prices have
been falling. Nations, such as Russia, are selling their stock because they are no longer
afraid of a major warfare in the near future.
The six majors and the markets they operate in have characteristics that are
conducive to coordination. Moreover, the market-share data in Table 3.2 show clearly that
Alcoa has dominated the other five, a pattern also supported by history. The only possible
challenger is Alcan, originally an Alcoa subsidiary. The remaining four have quite similar
market shares, which could encourage their tacit collusion, since they would be well aware
of the other's situation. In fact the majors have similar vertical and horizontal structures,
they each have production and selling operations in all major regions of the world, and
they have each invaded each other's home market. The firms also use the same basic
technologies, have similarly sized plants, and have similar cost structures. The firms
manufacture commodities (in the sense used in marketing studies) and although the
products are not all homogeneous, quality differences are easily measured. The products
are unbranded and largely undifferentiated.
TABLE 3.2
SHARES OF THE SIX MAJORS IN WORLD BAUXITE, ALUMINA, AND
PRIMARY ALUMINUM CAPACITIES: 1955, 1963, 1971, AND 1979
(In Percentages at Start of the Year)a
Stage of production
1955
1963
1971
1979
Bauxite
Alcoa
28.2
20.0
19.1
23.5
Alcan
25.6
22.4
14.1
8.1
Reynolds
16.4
13.7
10.6
6.7
Kaiser
11.0
17.3
12.3
8.1
Pechiney
4.7
6.7
5.3
4.5
Alusuisse
2.3
1.9
2.1
3.5
~ oalbt
88.2
82.0
63.5
54.4
Alumina
Alcoa
Alcan
Reynolds
Kaiser
Pechiney
Alusuisse
~otalb
24.8
27.3
16.9
12.3
5.1
4.2
90.6
18.0
26.3
15.4
11.7
8.6
4.6
84.6
23.0
19.0
11.1
12.2
11.0
2.9
79.2
Primary Aluminum
Alcoa
20.4
16.9
17.1
Alcan
26.2
19.2
19.9
Reynolds
15.0
13.4
11.8
Kaiser
14.6
11.6
8.4
Pechiney
5.8
8.1
10.0
Alusuisse
3.9
3.0
5.8
~otalb
85.9
72.2
73 .O
Source: Adapted fiom Stuckey (1983), pp. 84.
a. Based on plant capacity data in primary equivalents.
b. Equals the six-firm concentration ratio.
* . Of the remaining 37.1%, USSR produced 19% (Holloway, 1988).
27.6
13.9
9.2
9.4
8.9
4.8
73.8
15.1
16.3
8.8
7.8
8.3
5.9
62.9*
The major variables requiring coordination are price and quantity, the two variables
usually considered the easiest to coordinate in an oligopoly. Pechiney, has diversified into
other industries and during the 1970s Kaiser and Alusuisse also diversified away fiom the
aluminum industry. It is not obvious how these differences affect cooperation among the
firms, although it is argued that cooperation declines as the number of diversified firms
and their degrees of diversification increase (Stuckey, 1983). The average financial
performances and financial structures of the majors are similar, which is an assistance to,
and possibly an indication of, successfL1 cooperation. Most of the majors have ample
opportunity for, and give evidence of, effective interfirm communication (Stuckey, 1983).
This cooperation can strengthen the bargaining situation of the firms. However, the
invasion into each other's markets leads to competition between the firms which
undermines their ability to cooperate.
This structure, makes it difficult, for new firms, to enter the industry. The high
concentration and the limited free market in the upstream aluminum industry mean that the
potential entrant must choose fiom several difficult options, options that were even less
attractive prior to the mid-1960s. The typical strategy for a firm entering the industry has
been, first, entry into primary aluminum production and/or fabrication to secure a foothold
in the market, and then to integrate into other stages later. Entry barriers prevent
immediate complete integration. The six majors have an incentive to retain full and
balanced integration as a means of restricting entry. Entrants or unintegrated firms have an
incentive to become vertically integrated to avoid price squeezing or rationing by the
majors. Also, the fact that bauxite and alumina production are technically complementary,
means that without vertical integration, firms would operate in oligopolistic or bilateral
monopolistic markets. The bargaining costs and financial risks associated with these
market structures cause market failure, and firms resort to the relative efficiency of
internal organization. There are strong incentives for upstream integration for firms that
are integrated across mining, refining, and smelting, and often also semi-fabrication and
final fabrication (Graham, 1982), because they can have approximately balanced capacities
across the three stages (Stuckey, 1983). Each stage is associated with a higher added
value and the possibility of increased external economies as other inputs are brought under
corporate control (Graham, 1982). Those firms that do not have full balanced integration
are pursuing strategies to take them in that direction (Stuckey, 1983).
Joint ventures have been established frequently in the aluminum industry, especially
since the early 1960s. Such firms account for almost 50% of the industry's capacity.
Participation in joint ventures can make it easier for the individual firm to simultaneously
achieve balanced vertical integration, low unit costs, and sufficient markets for their final
output in the short run. The private advantages that accrue here would also seem to
accrue to society, at least potentially (Stuckey, 1983; Woods and Burrows, 1980).
"To the extent that joint ventures are a more efficient means than the alternatives of
organizing the intangible assets used in aluminum projects such as technical know-how
and nation-specific knowledge, society can again benefitfrom them. Intangrble assets are
difficult to transact at arm's length, because of contractual incompleteness and the risks
of strategzc misrepresentation, but when they are exchanged implicitly within a joint
venture, transaction costs and risks may be reduced, and this improves the industry's
performance." (Stuckey, 1983, pp. 209).
Furthermore, joint ventures make it possible for individual firms to add relatively small
chunks of capacity, hence each firm can share in the industry's growth while aggregate
capacity grows at a collectively optimal rate. Joint ventures also affect the industry's
performance to overcome entry barriers. Most successfid new entrants into the industry,
during the last decades, have relied heavily upon participation in joint ventures as part of
their entry and growth strategies (Stuckey, 1983; Woods and Burrows, 1980).
"The many joint ventures between the multinational aluminum firms and host
governments or private, localfirms seem to be initiated by the host country because joint
ventures are the best means by which a government can protect and promote the interests
of (ultimate&) its constituency.....The multinationals are often forced to accept local
partners, but there is some evidence that they too benefit from foreign joint ventures
because geographical diverszjication results within thefirm." (Stuckey, 1983,pp. 211).
Woods and Burrows (1980) also point out that by allowing non-aluminum firms to
purchase minority interests, in joint ventures, the aluminum producers can spread their
available capital over larger production capacity. It is also a way of bargaining for both the
HC and the firms. The market for aluminum has grown rapidly during the postwar period,
and as initial capital costs for aluminum production are quite high, the joint ventures
improve the ability for the already existing producers to expand their production. Joint
ventures reduce the risk of any one investment for each firm and allow firms to pool their
technical know-how and market experience. Finally, joint ventures allow firms without
bauxite or alumina supplies to pool their interest with firms that do have bauxite or
alumina production facilities.
Location Strategies and Barpaining in the Aluminum Industrv
The mining of bauxite and the conversion of bauxite into alumina is a weight losing
process and is therefore located near the source of the raw material to minimize
transportation cost. Although the smelting process is also a reduction process,
transportation costs are no longer the major locational determinant. Rather, the principal
locational cost is electricity while other costs are carbon electrodes, labour, and capital
costs. While all of these costs can vary with location, the most significant variations are in
electricity and labour (Brubaker, 1967).
"Comparative advantage in smelting is related to the availability of low-cost power,
which depends in turn on the endowments given to a regron by nature relative to the
demand for electric power from users. Still, it falls within the realm of public policy to
decide whether to develop low-cost power sources and, once developed, whether to use
the power for aluminum smelting. And it is a public policy decision to raise the price
existing smelters must pay for electricity and so reduce their international
competitiveness." (Peck, 1988, pp. 9).
The objectives of HCGs in attracting the aluminum industry are at least threefold;
to find outlets for surplus energy; to promote regional development; and finally, to
promote industrialization (OECD, 1983). Auty (1982) argues that the expansion of the
aluminum industry has encountered severe opposition in some OECD regions, for example
the Pacific North West and Australia, largely because of the low level of employment and
limited linkages per unit of energy used and because of potential threats to the
environment in the form of pollution.
Not only is the aluminum industry an extremely capital-intensive production
process, but usually certain operating costs are partially fixed in the short run. For
example, electric power and alumina are often bought under contracts that require
minimum (large-scale) purchases, and union contracts often impose cost penalties for
layoffs. Furthermore, there are costs, sometimes a few million dollars, in closing and
opening a smelter. As a result, a smelter will continue to operate, even if the price of
aluminum is below it's operating costs, if the firm regards the current price levels as a
short term condition (Peck, 1988).
Expanding an existing smelter is often cheaper than constructing a new one, that
is, up to some point usually set by such constraints as the supply of low-cost power, the
capacity of the transportation system, the availability of land and labour, and, recently,
potential environmental regulations. ~ e c a u s eof these factors, and the fact that low-cost
locations are not always available, producers tend to grab the opportunity if a low-cost
location becomes available and to initially build small smelters that are planned for
expansion a few years later. Kirchner (1988) argues that Alusuisse investment in Iceland in
1969 (see chapter 4) was a good example of a firm grabbing such an opportunity. A
'typical' example is to build a smelter with 60,000-100,000 tones of annual capacity with
the possibility of expanding until capacity has reach 200,000 tones or more giving that
economies of scale are important in aluminum smelting. It has been argued that smelters
below 100,000 tones of capacity will not be economically feasible. The U.S. aluminum
industry is a good example. By 1972 only four of the 32 existing smelters in the U.S. had
less capacity than 100,000 tones of annual capacity. The actual pattern of capacity
suggests that economies of scale may well exist beyond the 100,000 ton mentioned
repeatedly in the literature on the aluminum industry (Peck, 1988).
Electricity and bargaining
As mentioned earlier, the price of electric power is the major determinant of the
international competitiveness of smelters. It is the cost that varies most by geographic
location.
Electric power is produced in several ways: oil thermal generation, coal thermal
generation, nuclear power, geothermal energy, or hydropower. Each source has a different
level of cost. Oil is the most expensive at roughly 65 mills per Kwh, and hydropower is
the least expensive possibly as low as 15 mills per Kwh. Although electricity can be
transported over increasing distances, it is still consumed most economically in the region
in which it is produced. The economic consequences of these technological facts are that
the lowest cost smelters are located largely in regions with hydropower (see Table 3.1 and
3.3) (Peck, 1988).
Because the operating costs of hydropower facilities are low, about 10% of total
costs, there is a strong incentive, when a facility or a region has a considerable power
surplus, to attract aluminum smelters and charge low power rates. The importance of such
a strategy is that the rates charged to the user will make some contribution to the fixed
capital costs, even if those rates are well below those charged to other customers and
below the total (including capital) cost of generating electricity (Peck, 1988).
"The kind of bargaining that occurs between a primary aluminum producer and a power
supplier depends on whether the power will supply a new or an existing smelter. With a
new smelter the primary producer can compare the power costs at alternative locations
and bargain with each potential supplier of power - even though they may be thousands
of miles apart. For a nation to attract a smelter, it must offer power rates competitive
with alternative location." (Peck, 1988, pp. 15).
Table 3.3 shows different prices of electricity (1982), at different locations, to aluminum
smelters. The way of charging electricity has changed since the early 1980s. Most power
agreements charge electricity to the smelter as a calculated percentage of aluminum prices,
with a certain minimum and maximum charge. As a result, electricity prices fluctuate in
accordance to aluminum prices. For example the minimum charge in Iceland in 1994 is
12.5 mills per KWh and as aluminum prices have risen from US$ 1,000 per ton end of
1993 to almost US$ 1,500 in six months electricity price in Iceland has risen from the
minimum charge of 12.5 mill per Kwh to 12.81 mill per Kwh (MorgunblaiSiiS, 1994d).
TABLE 3.3
PRICE OF ELECTRICITY TO ALUMINUM SMELTERS IN 1982.
Location
Mills per KWh
Low-cost power locations
Australia
15-19
Brazil
13-17
Canada
8-16
~celand*
6.45*
High-cost power locations
U.S.
25-38
France
26
F.R. Germany
25
Italy
35
Norway
20
Greece
15
Japan
56
Source: Adapted from Peck (1988), pp. 23.
* . Source: (OECD, 1983). Note, this price rose shortly after 1982 (see chapter 4).
The bargaining process between the firms and the power suppliers, who are often
governments, is not a simple process. The bargaining often includes provisions for
taxation, local financing, and government finished infrastructure. High electricity prices
can thus be offset by liberal provisions in other areas (Peck, 1988).
Both parties are interested in electricity rates over the life of the smelter. However,
the primary producer is potentially at a disadvantage in that once the smelter has been
constructed, the producer loses a great deal of its bargaining power because it can no
longer consider other location options. Because of this, producers can use three methods
to try to prevent the offset and their loss of bargaining power once a factory has been
built. First, they can examine the possibility of owning their own power facilities. This
option requires large capital outlays, particularly for hydropower plants. Furthermore,
building dams requires government permission, which is sometimes not easily
forthcoming. Second, they can sign long-term contracts that guarantee low-cost power.
This has been the most common method for capitalizing on the producer's strongest
period of bargaining power, when they are choosing among sites. Yet, such contracts do
not provide complete certainty because they can be abrogated by governmental action.
Finally, they can diversify the location of their smelting among regions, among suppliers of
power, among power sources, and finally among nations. With such a diversity of sources,
actions related to a particular power supply will affect only some of the smelters of a
primary producer and so place the producer at less of a disadvantage vis-a-vis his
competitors (Peck, 1988).
Each of these options has disadvantages and none of them provides certain
protection from rise in power prices. The risk that power prices will change despite longterm contracts has become particularly great during the late 1970s and 1980s. Before that
time, power costs for aluminum smelters were usually set by long-term contracts, and they
usually did not change. However, the decade of the 1970s saw rapidly rising electricity
prices, reflecting the overall increase in power prices following the two oil shocks (Peck,
1988). Such price volatility in the major input has in turn complicated the bargaining
process that has at the same time become more important for both actors and determines
the competitiveness of the industry at different locations.
"The political influences in this whole bargaining process are also quite important
because power suppliers are often government agencies or, at least, regulated private
companies. Ihus the suppliers may have explicit objectives beyond selling power,
objectives such as promoting regional development or maintaining employment......
......Perhaps the only generalization possible is that the outcomes are diverse and
that the bargaining often determines the international competitiveness of a nation's
aluminum indusfry." peck, 1988, pp. 17).
The existence of the six majors may have a special significance for structural
adjustment to changes in international competitiveness. Because of their multinational
operations, these firms can locate new smelters in areas that have the best prospects for
the lowest cost operations with an ease that a strictly national company cannot match.
Irrespective of national location, the firms can also concentrate production at those of
their existing smelters with the lowest operation costs. However, their ability to
concentrate production in this way is limited by the start-up and shutdown costs,
expansion restrictions, union contracts and power contracts with minimum consumption
provisions.
The international scope of operation of the six majors gives the firms a good
position for effective bargaining on favourable power contracts and other concessions
when decisions on the location of new smelters are made. They can choose fairly freely
among countries, although competition for the 'scarce' supply of low-cost power limits
their bargaining power. However, it is unclear, just how much the six major's status
increases such bargaining power peck, 1988).
Auty (1993) points out that the concept of obsolescing bargaining (developed by
Vernon, 1971; 1980) applies to the bargaining process of the aluminum industry. During
the feasibility stage, when the terms of the project are negotiated the MNC has the
strongest bargaining position, it has most information and only a modest financial
commitment, whereas the HCG is keen not to deter new investment. By the time the
investment has been completed, the HCG has a stronger position, much of the secrecy
surrounding the prospects for the project has lifted and the HCG can seek renegotiation of
the concession secure in the knowledge that the MNC is now vulnerable because it needs
to secure the return of its capital, with a profit. Yet both sides can gain by eliminating such
potential friction through transparent taxation agreements.
B a r ~ a i n i nStructure
~
in the Aluminum Industry
Peck (1988) concluded that the bargaining process 'determines the international
competitiveness of a nation's aluminum industry'. Since the outcome of the bargaining
process relies on the relative bargaining power, bargaining ability, and the interdependence
of the each actor, both sides have certain advantages. Aluminum firms, such as the six
majors, are big powerfid firms that, prior to an investment, explore every possible location
option in detail and by comparing them they gain a certain advantage in upcoming
negotiations. Competition between nations and regions seeking investments hrther
increases this advantage. According to Auty (1993) this advantage shifts over time. The
MNC becomes more vulnerable after investment has taken place and the HCG gains
-
'power'. However, since the aluminum industry requires specific location characteristics
some locations hold advantages over others because they (better) hlfill these
requirements. Exactly in what environment a new smelter, then, operates in, is subject to
the bargaining process.
As these big aluminum corporation explore possible location options countries like
Iceland, which only recently entered the scene as a possible location, try to get their
attention. Fulfilling all the industry's requirements, Iceland is a good option for the
aluminum industry. Since the bargaining process determines the operating location
conditions of aluminum MNCs it is necessary to examine this process, in detail, to
understand the international competitiveness of a certain location. This is the subject of the
following two chapters which are case studies of the aluminum industry in Iceland.
CHAPTER IV
THE BARGAINING PROCESS BETWEEN THE
ICELANDIC GOVERNMENT AND ALUSUISSE (1960-1966)
Introduction
This chapter examines the negotiations between the Icelandic government and
Alusuisse, a Swiss aluminum multinational corporation (MNC) (Table 4.2), that preceded
the establishment of an aluminum smelter, Icelandic Aluminium Co. Ltd. (ISAL), in 1969.
These negotiations are analyzed within the frameworks of the bargaining process outlined
in chapter 2, in particular the model developed by Contreras and Gregersen (1975) and
models of the obsolescing bargaining developed by Kobrin (1987) and Vernon (1971;
1980; 1985).
Before examining the actual bargaining process the main outcomes of the
negotiations are outlined and a chronology of events is included (Table 4.1). Then broad
issues that were debated are introduced. First, issues that were debated within Iceland,
such as foreign investment, foreign ownership and control and the development of Hydroelectric power, and second, issues that were debated within Alusuisse, for example other
location options than Iceland are discussed. These short discussions help to explain and
more hlly understand the complex bargaining process that follows. Also, before
describing the actual interactions, it is necessary to identifl motivation factors for both
Alusuisse and the Icelandic government and situations where there is 'conflict' and/or 'no
conflict' in motivation. Since the plant was established, all the 'conflict' situations that
both parties anticipated at the beginning of the negotiations, notably location, price of
power, taxes, and import duties, and issues that surfaced during the negotiations such as
legal issues, were 'negotiable' (see Figure 2.3). Subsequently, after examining the
bargaining process, spin-offs and benefits of the bargaining process are discussed.
Alusuisse and the Icelandic government were not the only participating parties in
the negotiations. When negotiations began Alusuisse had a partner, American Metal
Climax (AMC, later Alumax (see Chapter 5 and Table 5.2)), and they were working
together towards erecting an aluminum smelter in Iceland. However, AMC's decision to
drop out of the project in 1964 did not affect the negotiations. Alusuisse and the Icelandic
government were determined to continue negotiations. Another actor that influenced the
outcome of the negotiations was the World Bank. The bank joined the negotiations in
1964 when the government started negotiations to raise capital to finance the construction
of the Burfell power plant that would provide the new aluminum smelter with energy.
The Barpain: Kev Elements
After intense negotiations between 1961- 1966 the Icelandic government and
Alusuisse signed a Master Agreement on March 28, 1966.
This Master Agreement had to be approved by both the Icelandic Parliament and
the Board of Alusuisse. Because of the matter's importance, it was put forward in the
Parliament on April 1 and then approved, after very long discussions, on April 30, 1966
(MorgunblaiSiiS, 1966b; Hafstein, 1966b; AlbingistiiSindi, 1966), and a little later the
Master Agreement was also approved by the Board of Alusuisse.
ISAL, located in Straumsvik on Reykjanes, is provided with electricity from the
Burfell Hydro-power plant (see Figure 1.1 and 5.6). The first delivery date for electricity
was, according to the Agreement, to be June 1, 1969. At that time Burfell was supposed
to be ready to deliver electricity and ISAL should have finished erecting a 30,000 ton
aluminum smelter. However, in the Agreement there was a clause which gave both parties
the opportunity to postpone this date, for a short period of time (Icelandic government
and Alusuisse, 1966; Hafstein, 1966b). As it turned out, the start-up day June 1 was
postponed and operation of both facilities did not begin until October 1, 1969.
According to the Agreement, the price of power in 1969 was 3.0 mills per Kwh.
The Agreement required that this price would stay unchanged for the first six years but
would be lowered to 2.5 mills after that time. Instead, the smelter would pay lower taxes
during the first six years of operation and these taxes would be raised as the price of
power dropped. After the first six years the smelter was expected to have reached its full
annual production capacity of 60,000 ton. Simultaneously with the enlargement of the
smelter, the Agreement anticipated that Burfell power plant would be enlarged from its
original 105 MW production to a fully built 210 MW power plant. The Burfell power
project was supposed to be financed through loans fiom the World Bank and subsequent
expansion was also supposed to be financed by the World Bank.
Taxation of ISAL was a fixed amount for each produced ton of aluminum.
According to the Agreement the smelter was supposed to pay US$ 12.5 per ton during the
first six years of operation. After these six years this amount was supposed to rise to US$
20 per ton and after nine more years to US$ 35. The Agreement also included a clause
about maximum and minimum tax.
According to the Agreement the smelter is exempt from import duties on
machinery and raw materials.
Also, according to the Agreement ISAL is a Icelandic firm but is exempt from
some laws and regulations. The firm is 100% owned by Alusuisse and disagreements
between the government and Alusuisse will be solved by using an international court of
arbitration which, however, will use Icelandic laws as guidelines.
The duration of the agreement is 25 years, but both parties can extend the
agreement for another 10 years which means that the scope of the Agreement is
potentially 45 years.
Since operation of ISAL began on October 1, 1969 the plant has produced close to
2 million ton of primary aluminum. Since 1993 the smelter has had an annual production
capacity of 96,000 ton. The company's main exports consist of aluminum slabs and other
cast products made for ISAL's sister companies in Europe, which make final aluminum
products for sales and export. So, the smelter has been 'success~l'. However, the
decisions reached in the Master Agreement of 1966, and made operational with some
modification at the plant's start-up in 1969, evolved after intense debate which
contemplated various alternatives (Table 4.1). At the national level, there was considerable
debate within Iceland about whether an aluminum smelter should be built at all and if so, if
it should involve a MNC. Once these conditions had been (more or less) accepted,
decisions had to be reached regarding various characteristics of the aluminum smelter.
These were, most notably, location, price of power, taxation, import duties, environmental
issues and legal issues. However, before examining each of these issues separately, the
next section will examine the context of debate, especially focusing on the debate within
Iceland preceding and during the negotiations between the Icelandic government and
Alusuisse.
The National Context of Debate
Prior to, and especially during, the negotiations with Alusuisse there was a debate
in Iceland concerning two vital issues concerning the aluminum project. In particular, there
was a debate over 'foreign investment' and foreign capital entering Iceland and a debate
over the fbture development of power production in the country. This section will also
examine issues that were openly discussed within Alusuisse, such as other location
options.
TABLE 4.1
CHRONOLOGY OF EVENTS DURING THE NEGOTIATIONS BETWEEN THE
ICELANDIC GOVERNMENT AND ALUSUISSE 1960-1969
Date or Period
October 1960:
Comments:
Alusuisse sends the Icelandic government a letter stating interest in erecting an
aluminum smelter in Iceland.
The government receives a questionnaire (Table 4.3) from Alusuisse, were the firm is
June 1961:
looking for information whether Iceland is a feasible location for a new aluminum
smelter.
During 1961:
The government establishes TIDC to continue negotiations with Alusuisse.
November 1961: Both parties meet in Ziirich. The government is to prepare a memorandum that outlines
commitment's which it is possible to make at this stage. Also discussions about
electricity price.
TIDC asks Alusuisse to build a larger plant, than 27.000 ton, to make constructions of a
April 1962:
power plant more feasible.
The government promises that import duties would not be an obstacle in the
During 1962:
negotiations.
November 1963: Both parties agree on price of power and that there should be a connection between price
of power and taxation. An idea for a tax formula was put forward.
During 1963: Harza Engineering recommends Blirfell as the best option for a new power plant.
The g o v e m e n t negotiated with the World Bank to raise capital for Blirfell power
During 1964:
project.
September 1964: Alusuisse decids that Straumsvik would be the best location for the smelter.
October 1964: The World Bank argues that taxes + price of power can not be lower than 3,7 mills
per Kwh otherwise the project would not be economically feasible for the government.
December 1964: Both parties reach an agreement concerning most issues for example the tax formula
and price of power (see appendix 1). The World Bank agrees to finance the Burfell
power plant project.
January 1965: A draft of the Master Agreement is ready.
Alusuisse argues that a 30.000 ton smelter is too small. It is decided that Alusuisse
March 1965:
will build a 30.000 ton smelter which will be enlarged within 6 years to a 60.000
ton smelter.
A final agreement of taxation is negotiated. Two conflicts occun; first, the duration
During 1965:
of the agreement; and second, the jurisdiction of the smelter.
March 28, 1966: A Master Agreement is signed and approved first by the Icelandic Parliament and then
by the Board of Alusuisse.
October 1, 1969: Operation of the smelter begins.
The debate within Iceland
In 1918 ideas for building large power plants in Iceland were first put forward.
Simultaneously, ideas for power intensive industry were also suggested including, for
example, construction of a fertilizer plant, an aluminum smelter, andlor even iron or zinc
industry. At this time (1918), circumstances in Iceland were totally different, Danish
influences were still very powefil and people afraid of foreign capital and control. Since
then, circumstances have gradually changed (Nordal, 1965c; Jonsson, 1965). Though
foreign capital had entered Iceland prior to the 1960s, it was principally in the form of
loans to strengthen existing industries. It had been the government's goal and practice,
since the country became sovereign in 1918, that Icelanders should own firms that
operated in the country. This policy enabled Icelanders to control and develop resources
located in the country. Consequently, the beginning of negotiations with Alusuisse in the
early 1960s marked a major change in that policy. Jbnsson (1966) pointed out the danger
for small nations in relying on large MNCs:
"By inviting a MNC into the country the government has lost faith in its own people. So
far the nation has been able to do things of its own and why not now as before. The
counfry should use its own resources and projts should stay in the country. Iceland
should have control over its resources and activities within the country. Though by
allowing one MNC into the country, Iceland will probably not lose its control but other
MNCs will follow and the country can lose its control. This is what has been happening,
for example, in South America." (Jbnsson, 1966, pp. 1372).
Entry barriers facing foreign investment into Iceland are different from many other
countries. Thus resources have traditionally been protected from foreign ownership and
control with laws and regulations (see chapter 1) but by potentially allowing Alusuisse to
construct an aluminum smelter, the government proposed a change to these laws which
potentially opened up the possibility that other foreign firms would enter Iceland. For the
critics of foreign investment such development threatened the independence that has so
recently been established (Olgeirsson, 1966; Josefsson, 1966). In response, the
government's negotiators and supporters argued that the MNC is not coming to Iceland to
take over the country or destroy its freedom. Rather, the MNC's attraction, to Iceland, is
because it sees financial gains in locating there. In addition, Hafstein (1965) argued that
the government would only allow foreign investment in the country if Iceland would see
some economical benefits from such an investment and if it would not threaten
economical, social, nor political independence of the country. According to Nordal
(1965~)there is no chance that Alusuisse's investment will in any way threaten Icelandic
independence because though Iceland is dealing with a very powerfbl MNC, it is owned
and governed in Switzerland which is a small neutral country and the MNC will not have
unlimited right of operation in Iceland. Nordal further argued that in the agreement then
being negotiated, there are no doubts about Alusuisse rights and duties, so by negotiating
with this MNC Iceland is not opening up for other MNCs without earlier negotiation
(Nordal, 1965~).
One way for countries to protect their sovereignty from MNCs is to demand that
the new firm must be a joint venture between the MNC and the governmental and/or local
firms. Indeed, such joint ventures have been widespread in the aluminum industry (see
chapter 3). However, the idea that the proposed smelter could be a joint venture between
the Icelandic government and/or local firms and Alusuisse is nowhere to be found in the
references. The reason could be that the government realized that the related power
project which would be so large that it would be impossible to provide capital for such a
joint venture. In addition, the proposed smelter did not impose any threat to the
government's policies of protecting natural resources located in Iceland.
Critics of foreign investment (Jonsson, 1966; Helgason, 1965; Olgeirsson, 1966)
argued that a MNC that will invest US$ millions will protect its investment and in doing so
the firm will seek to lobby powerfbl persons in Iceland. They argued that even if it is not
dangerous to let some foreign capital enter Iceland, an investment of the size that the
government is now negotiating with Alusuisse is too large to be taken in one step. For
these critics, the Icelandic economy is too small to handle such an investment and the
consequences could be devastating as, foreign capital could in a short period of time
overtake the Icelandic economy, and by doing so threaten the political independence of the
nation.
"ThisMNC will be the most powerful force in Icelandic politics during the next decades."
(Olgeirsson, 1966, pp. 1437).
The critics hrther argued that the proof that the government is doing something wrong is
how eager the Swiss firm is to sign an agreement with the government (Olgeirsson, 1966;
Josefsson, 1966; Jonsson, 1966; Valdimarsson, 1966; Kjartansson, 1965; Amalds, 1966).
They even quote one of Alusuisse directors, in a interview, arguing that 'Alusuisse owns
smelters all around the world but this was the best agreement, and the lowest electricity
price, the firm had ever negotiated'. Even after the government had signed the Master
Agreement the critics of foreign investment continued to raise this issue:
"A well-trained negotiating committee from Swiss has gotten a signature from the
Minister of Industry, approved by the government and they don't know the
consequences." (Olgeirsson, 1966, pp. 1596).
Within Iceland, the debate over foreign investment during the 1960s was hrther
complicated by a debate over a new Hydro-power plant(s) for domestic use. The
development and utilization of Hydro-power became a fierce debate and because the
location of a new power plant was closely interrelated with the location of a new
aluminum smelter, this debate was of most importance to the negotiations.
One the side of the government, Jonsson (1965) argued that from the beginning of
time Icelandic rivers have run freely to sea without any economical benefits. In addition,
he noted that some scientists had forecasted that in 20-30 years Hydro-electrical power
plants would not be able to compete with nuclear power plants. Given that power from
such plants is becoming cheaper, Jonsson (1965) emphasized the need for Iceland to start
building Hydro-power plants as soon as possible since if it did not the country might lose
its advantage, over other locations, in offering cheap power to industries andor MNCs.
"It is not only childish to wait, it is a crime tavardsfuture generations." (Jonsson, 1965 pp.
19).
After Harza Engineering, an engineering company hired by the government in
1961 to examine possible sites for Hydro-power plants, recommended that Burfell would
be the best location for a new large power plant, the government examined three possible
strategies. The first strategy was to build many small power plants only for domestic use,
each of them fairly cheap to build but they would have a much higher operation cost (per
Kwh) than one larger plant such as Burfell. The second strategy they considered was to
build the first step of B6rfell (1 10 MW) without the market of power intensive industry.
The third strategy considered was to build the Burfell (110 MW) power plant in
connection with power intensive industry and to enlarge the plant, in two or three steps, to
a size of 210 MW, that would produce electricity at half price, compared to many small
power plants (Nordal, 196%; Jonsson, 1965).
The government argued that strategy two could be eliminated because the
government would never be able to finance such a large project without power intensive
industry. The first strategy would also have some financial constraints and is not as
feasible as the third strategy because of the high operating cost. Therefore, according to
the government and its supporters the third strategy is not only the cheapest option but
also.the best (Nordal, 196%). In support of this view, the government argued that the
power agreement currently being negotiated with Alusuisse is going to pay for 213 of the
construction cost of a 210 MW power plant at Burfell. A 60,000 ton aluminum smelter
will only use 112 of the energy (1 10 MW) and after Iceland finishes paying the loans and
interest of the financing for the power plant (with income from power sales to the
aluminum smelter) over an estimated 25 years, it will not only own the plant but the power
plant will also be a source of income (foreign income) for future generations (Nordal,
196%; Jonsson, 1965). It should be noted that by signing a Master Agreement with
Alusuisse the government did not have any other options than to follow the third strategy.
However, this rationale was criticized within Iceland.
The Icelandic negotiating committee was criticized for presenting cofising figures
to the public. Critics argued that total estimated foreign income from building the
aluminum smelter and income from electricity sales to the smelter are too high (Helgason,
1965; Kjartansson, 1965).
"This is done on purpose, so the ozttcome of the new power intensive industry will be
better." (Helgason, 1965, pp. 19).
Kjartansson (1965) also criticized the power agreement on the basis that the cost
of constructing the power plant were underestimated by Harza Engineering and the
government. He claimed that problems like ice and mud flows had not been thoroughly
investigated. Therefore the electricity price is much too low. According to Jonsson
(1966), the Agreement permits Alusuisse to pay 28% less for electricity in Iceland than it
is doing in Norway (Husanes aluminum smelter; see Table 4.2). In addition, Jonsson
(1966) noted that if the estimated construction cost of building the Bbrfell power plant
rises by 3.3% or more, the result would be that Alusuisse would pay less per KWh than
the production cost per Kwh (assuming the price will be 2.5 mills per Kwh, which had
been anticipated by Alusuisse). According to Josefsson (1966) 2.5 mills is the lowest
electricity price to an aluminum MNC in Europe. Even if the electricity is paid in foreign
currency Kjartansson (1965) suggested that the government will maybe devalue the
Icelandic currency after the agreement has been signed and by doing so, increase its
income, but at the same time, ruin the economic status of the country. Another problem
raised by critics of the government was that a simultaneous construction of a power plant
and an aluminum smelter would add to the already expanding economy. Such expansion
will increase the inflation rate, which will only create problems in other industries such as
the fishing industry. In this view, the project as a whole is working against Iceland's own
interest (Valdimarsson, 1966).
According to Harza Engineering (1962), the Burfell power plant offered the
cheapest option for energy production in Iceland. Without an aluminum smelter, the
energy it produces would last the nation until 1985. However, the critics noted that with
an aluminum smelter it will only provide domestic users with electricity until 1976 which
means that in 1976 Iceland would have to build a new power plant to produce electricity
which will have higher operation cost per Kwh than Burfell, which ultimately will lead to
higher electricity price for Icelanders and Icelandic firms. That is:
"The cheapest and the best power plant will be used for foreigners and Icelander's will
have to pcly for it in the fu fuve." (Jonsson, 1966, pp. 1385).
However, the critics lost the battle and the government used its majority in the
Icelandic Parliament to approve the Master Agreement with Alusuisse. It should be noted
that the discussion in the Parliament was a month long, from April 1 to April 30 (the long
discussion can be found in Albingistiaindi (1964B) pp 135 1- 1960, 2696-273 8). In addition
it should be noted that the government only had a marginal majority of one vote.
Alusuisse options
As the largest European producer of primary aluminum and the sixth largest
producer in the non-communist world in 1960 (see Tables 3.2 and 4.2) Alusuisse
examined many location choices prior and during the negotiation with the Icelandic
government. During the negotiation period (196 1- 1966) Alusuisse finished erecting a new
aluminum smelter in Husanes (Norway), which is one of three remaining (1994) smelters
operated by Alusuisse (see Table 4.2). Alusuisse was also negotiating with governments in
Germany and Sweden about building aluminum smelters in those countries that would
have been the firm's first smelters provided with energy fiom nuclear plants (Hafstein,
1966a). In the 1960s the firm was also investigating location possibilities in Africa.
TABLE 4.2
ALUSUISSE - SELECTED CHARACTERISTICS
Date or Period
November 12, 1888:
Before 1940:
1960:
During the 1970's:
January 1, 1990:
Current status:
Aluminum:
Comments:
Alusuisse was founded under the name of Aluminium Industrie Aktien
Gesellschafi (NAG) (e. Swiss Aluminum Ltd.). The firm was the first
aluminum producer in Europe to apply electrolytic reduction process invented
in 1886 by Heroult.
The Alusuisse Group invested only in Europe.
The firm was the largest primary aluminum producer in Europe and the sixth
largest producer in the noncommunist world (Table 3.2). The firm is not only
a multinational producer of primary aluminum but also a major producer of
semi-finished and finished aluminum products.
Alusuisse diversifies into other industries such as chemicals, engineering,
energy, and mining. Because of this interest the firm acquisisted Lonza Ltd. a
major Swiss producer of chemicals, plastics, and fertilizers.
The present name Alusuisse-Lonza Holdings Ltd. was adopted.
Alusuisse conducts its business in Switzerland and in 26 other countries (for
example: Austria, Germany, France, Italy, U.K., Canada, U.S.A., Sierra Leone,
and Iceland, to name a few). Within Switzerland Alusuisse activities are carried
on both directly by it and indirectly through subsidiary and aflliated
companies. Outside Switzerland Alusuisse operates solely by means of
subsidiaries and affiliates. The activities of the Alusuisse Group are carried on
in six main Divisions: Aluminum, Mining, Chemicals, Engineering, Energy,
and Research and Development.
The most recent development of the aluminum division is that the firm has
been focusing more on semi-finished and finished products and has been
reducing its primary aluminum production. The firm has been reducing its
production especially in the U.S. and is focusing more on production in Europe
and the Far East. At the beginning of 1994 the firm had only 3 producers of
primary aluminum in Europe. One in Germany (estimated production for 1994
30,000 ton), one in Norway (the Husanes smelter) (estimated production for
1994, close to 100,000 ton) and one in Iceland (ISAL) (estimated production
for 1994 96,000 ton). The goal is to close down the smelter in Germany in the
nearest future and if further reduction will occur the smelter in Iceland will
close next because electricity is cheaper in Norway after recent changes in
taxation there.
Source: Adapted fiom Moody's Investors Service (1993a); GuiSmundsson (1966); TIDC
(1963); MorgunblaiSiiS (1994c).
Apart from other location options two other issues were of importance to the firm
in relation to the Iceland investment. First, the firm had to decide whether to continue with
the project after AMC dropped out of the proposed project in 1964, and second, the firm
had to resolve legal issues that were not anticipated by neither the Icelandic government
nor Alusuisse at the beginning of the negotiations. The issue concerning AMC never
became an obstacle to the negotiations, but, as will be explained later, the debate
regarding legal issues almost prevented that Alusuisse and the Icelandic government
reached an agreement.
Obiectives and Motivation Factors
In this section the objectives and motivation factors underlying the establishment
of an aluminum smelter, first of the Icelandic government, and the second of Alusuisse, are
examined.
Icelandic Government
Power intensive industry was introduced during the 1950s in the form of a
fertilizer plant and in an attempt to hrther develop such industry the Icelandic government
founded TIDC (The Industrial Development Committee) in 1961 (RannsoknaraB Rikisins,
1975). The main reason for establishing this committee was that on October 15, 1960, the
government received a letter from a Swiss aluminum firm MAG (referred to as Alusuisse,
see Table 4.2) which stated an interest in building an aluminum smelter in Iceland. The
original idea contained in the letter was to build a 20,000 ton aluminum smelter if an
agreement could be reached about energy price, taxes, tariffs and other important issues
(Briem, 1963). This letter and the fact that Norwegian specialist (see Chapter 1) had
recommended aluminum industry as the best option for power intensive industry in Iceland
were the main reasons why TIDC put most of its time and effort on establishing an
aluminum industry in Iceland.
In June 1961 the government received a questionnaire from Alusuisse concerning
this project (see Table 4.3). This questionnaire focused on power cost and power supply
as power is the most important locational cost for aluminum smelters (see Chapter 3). In
addition Alusuisse was looking for answers regarding other important issues, such as,
taxation, labour, depreciation rates, and location within Iceland. The answers from the
government to this questionnaire were promising and the two parties met in Ziirich
between November 15-22, 1961. The outcomes of those discussions were that the
Icelandic government was to prepare a memorandum outlining the commitments which the
government was prepared to make at this stage with regards to import duties, taxes and
depreciation rates, housing for labour and other social expenditures, harbour and road
facilities, and other commercial problems that have come up in the discussion so far
(TIDC, l962a).
Some time during 1961-1962, the government started examining how an aluminum
smelter would affect the economy and how it could rationalize the negotiations with a
MNC to the Icelandic public. From the beginning, the government emphasized that an
aluminum smelter would make it possible for the country to use and develop the energy
resources more efficiently and speed up industrial development in doing so (TIDC,
1963a). The government argued that Iceland needed more electricity for domestic use and
if an aluminum smelter was not built the government would have to build several small
power plants, each of them with higher operating cost per Kwh than a large plant; capital
constraints would make it impossible for the government to build a large power plant
without power intensive industry. So the government was standing at a crossroads
concerning development of the energy resource (TIDC, 1963a; 1963b). The government
and TIDC also expressed their fear that this could be one of the last chances to produce
electricity by Hydro-power plants, because later nuclear power plants would produce
cheaper electricity. In addition, the government argued that if political situations in some
Third World countries would stabilize, they could produce electricity cheaper than
Iceland. In this regard the government cited an example of Congo that not only could
provide cheaper electricity but was also a source of bauxite, and would therefore become
a more favourable location than Iceland (TIDC, 1963b).
The government also claimed that the direct income of foreign capital would have
a positive impact on the economy. In particular, the government stated that these positive
impacts would be felt during the construction of the smelter and also later because of
other income, for example taxes, sales of electricity, labour cost, and other services
(TIDC, 1963a). In addition, as mentioned earlier (chapter l), the government thought it
necessary to secure a more diversified industrial base in the country beyond the fishing
industry that has been the main source of export income through the century. A more
diverse economy would not only be a new source of foreign income, it would also help in
stabilizing the economy, which had been characterized by large fluctuations during the
1950s and 60s. Finally, an aluminum smelter would create new jobs (Hafstein, 1965;
Nordal, 1994). The government also noted that power intensive industry would help in
raising capital to build a new power plant. They noted that by erecting a power plant and
an aluminum smelter simultaneously financial institutions would be more willing to provide
capital for such a project, because the new power intensive industry would secure
payments and profitability of the project. (Nordal, 1965c; 1994; Jonsson, 1965).
TABLE 4.3
QUESTIONNAIRE FROM ALUSUISSE TO THE ICELANDIC GOVERNMENT
The two main auestions are:
1) What are the Power Costs in the South West or in the North delivered free trans mission line at the
smelter?
2) Are there any plans as to how the funds for the power plant, transmission lines, harbour facilities etc.
could be raised?
Other auestions are:
3) What are the present rates for labour?
a) skilled
b) unskilled
What are the additional social charges?
Is there any likelihood that wages will rise further?
Does a Government pension scheme exist?
4) Can 2501300 workman be made available
a) near Reykjavik?
b) near Akureyri?
5) What is the present taxation on an Aluminium Smelter?
a) Capital taxes
b) Government revenue taxes
c) Local taxes
d) Turnover taxes (for Export or Home consumption)
e) Taxes on Imports
f ) any other h ~ e s
6) What is the normal rate of depreciation on
a) buildings
b) heavy electrical equipment
c) furnaces
d) transport facilities
e) others
7) Is the estimate of 10% annual cost on the Power Station a sound one?
8) What are the freight rates between
a) Rotterdam and Reykjavik
"
"
Akureyri
b)
for Aluminium Ingots
Alumina (Aluminium Oxide)
Kryolith, Fluorith, Coal, Coke
Is there a regular service to Akureyri?
Should the Iceland flag be preferably used?
9) Are there any other industries wanted in Iceland as electricity consumer?
10) The length of the transmission line from Burfell or Gullfoss to Reykjavik is said to be about 100
km.What is the length from Dettifoss to Akureyri?
11) What are the regulation in Iceland for founding an industrial work by a foreign company?
12) Could a degree of the Government avoid the menace of a strike in an Aluminium smelter, which
would create very heavy damage?
(MAG, 1961).
Alusuisse
In the early 1960s Alusuisse was looking for a location for an aluminum smelter
that would fulfill several key conditions. In particular, Alusuisse wanted cheap energy
prices, a stable economic and political situation, and a good location concerning
transportation. In attempting to examine and compare different location options Alusuisse
sent the government a questionnaire (Table 4.3). After receiving promising answers and
because Iceland appeared to fulfill basic requirements regarding the establishment of a new
aluminum smelter, Alusuisse was prepared to begin negotiations with the Icelandic
government. Another important factor, to Iceland's advantage, was that at this time
Iceland was considering whether it should join other European countries in EFTA, a
decision which would connect the country better to Europe were Alusuisse7s main
markets are (Nordal, 1994).
Interactions between the Icelandic Government and Alusuisse
It became evident early in the negotiations between Alusuisse and the Iceland
government that motivation factors and objectives were mostly complimentary and both
parties were eager to meet and begin discussing matters in more detail. At the beginning of
the negotiations the government did not put forward any minimum requirements. As
mentioned earlier, the government's main goal was to diversifL the economic base and to
get adequate revenues from sales of electricity (Nordal, 1994). Alusuisse, on the other
hand, did put forward, at the beginning of the negotiations, requirements that electricity
price should be close to 2 mills per Kwh, or at least not higher than 2.5 mills (TIDC,
1962; Nordal, 1994). This requirement and others anticipated by both parties changed as
the negotiations evolved. These negotiations were organized around five main themes:
location of the smelter, power supply, taxes, import duties, and legal issues. Although
each issue is examined separately it should be noted that they were clearly related and do
overlap.
The Location Question within Iceland
Very early in the negotiation the question of location became critical, and at a
meeting in April 1962 both parties agreed to give immediate priority to finding a location
for the smelter. Both parties initially recognized that five locations should be examined:
Geldinganes, Porlakshofn, and Straumsvik on the South coast (see Figure 5.6), and
Akureyri (Gaseyri), and Husavik on the North coast (see Figure 5.4) (TIDC, 1962b).
These five locations, prior to the 1960s, had been given attention when power intensive
industries were first examined in Iceland. In addition, the locations on the North coast had
to be included as in 1962 there was no decision whether the Icelandic government was
going to build the power plant on the North coast or the South coast. It should be noted
that an aluminum smelter on the North coast implied reliance on a power plant at Dettifoss
(Figure 5.1) while an aluminum smelter on the South coast implied relianck bn a power
plant at Burfell.
e
In September 1964 Alusuisse released a feasibility report about the proposed
smelter (Alusuisse, 1964b). In the report, Alusuisse compared what it considered the two
best possible sites in Iceland, Straumsvik and Gaseyri (see Figure 5.1 and 5.6). It is stated
in the report that these are the two best locations. However, there are no clear arguments
why the other three locations were excluded. Some argue that Straumsvik had been the
choice all the time and Gseyri had only been included as it fitted well into regional
development policies. Table 4.4 shows the capital cost comparison, for a 30,000 ton
smelter, between Straumsvik and Gaseyri.
TABLE 4.4
CAPITAL COST COMPARISON, FOR A 30,000 TON ALUMINUM SMELTER,
BETWEEN TWO SITES IN ICELAND, STRAUMSW
AND GASEYRI
Straumsvik
Gasevri
Alusuisse exvenses
uS$000.000
Construction in 1964
21.7
including 5% price increase
per year until constructions
begin
26.6'
Iceland expenses
harbour
road constructions
housing; for labour
Total
1.6
0.02
0.35
1.97
24.5
1.5
0.1
4.0
5.6
*including a inflation factor
Source: Adapted from Alusuisse (1964b).
Alusuisse stated in its feasibility report that it preferred to build the smelter at
Straumsvik rather than Gaseyri. Indeed, Straumsvik represented the cheaper option, not
only from Alusuisse perspective but also from the Icelandic government's point of view
(see Table 4.4) (Alusuisse, 1964b). In fact, it is also cheaper for the Icelandic government
to provide Straumsvik with energy, because it is closer to the Burfell power plant which is
Iceland's cheapest and best location for a power plant, in terms of operating costs.
The government was criticized for giving other regions, especially Akureyri (or the
Eyjafjorijur region; see Figure 5.4), false hopes, regarding location of the smelter. Critics
argued that it was never the intention to build the smelter there or anywhere else other
than the Greater Reykjavik area or Reykjanes (Teitsson 1965; Gislason, 1966). Critics,
such as Jonsson (1966), pointed out that by locating the smelter close to the largest town
it would increase the difference between the Greater Reykjavik area and the hinterland.
According to Jonsson (1966), it is the only place that the aluminum smelter should not be
located. He argued that one of the reasons why the smelter was not located on the North
coast was because if a power plant were built at Dettifoss it would be too big for a 30,000
ton smelter. However, in 1965 Alusuisse argued that a 30,000 ton smelter was too small
and that they were going to build a 60,000 ton smelter which in turn meant that a power
plant at Dettifoss was no longer too big. Jonsson (1966) and Gislason (1966) argued that
at this time the government should have made the North coast a priority for the smelter
and instead of erecting a power plant at Bbrfell they should build a power plant at
Dettifoss. Hafstein (1966b) emphasized that the government had wanted to build the
smelter on the North coast but Alusuisse was not prepared to build there. The firm gave
three reasons for its reluctance to locate on the North coast. First, Alusuisse noted that it
would be more expensive to build on the North coast (see Table 4.4); second, they argued
that pollution control equipment would be needed on the North coast but not on
Reykjanes; and third, on the North coast there is a threat that drift ice could close the
harbour as happened during the winter 1965-1966 (Rafnar, 1966). The government's
original intention to build the smelter on the North coast reflected its concern for regional
development within the country, and to prevent migration from rural areas to the Greater
Reykjavik area. Indeed, once the decision was made to locate the smelter at Straumsvik,
the government decided to spend part of the tax income from the smelter to create jobs in
other regions in an effort to equal regional development in the country (Hafstein, 1966b).
It is Nordal (1965a) that first mentions pollution control and environmental
hazards with regards to the aluminum project. According to Nordal (1965a) both
Alusuisse and the Icelandic government agreed that Alusuisse should carry all
responsibilities concerning pollution and environmental accidents. Also, according to
Nordal (1965a), if the smelter were to be located at Straumsvik, in the lava South of
HafnarfjorBur (see Figure 1.1 and 5.6), there is no threat of damaging the environment.
Straumsvik is an open space location with little vegetation and winds blow towards the
ocean and there is almost no threat of dangerous pollution in the ocean from an aluminum
smelter. Some environmental scientists opposed those arguments and argued that no
matter where the smelter is located pollution control equipment should be required.
However, at Gaseyri which is located in an agricultural area both parties had concerns
about environmental pollution. According to Valdimarsson (1966), Herr Meyer, an
Alusuisse Director, said in an interview that Iceland is the only country that Alusuisse has
negotiated with that did not require any pollution control equipment. Apparently the
reason given why the smelter will not be required to use pollution control is that there is
no research which indicates the need for pollution control. If research, which is supposed
to be conducted after the smelter has begun operation, shows that such equipment is
necessary, Alusuisse will provide the smelter with pollution control equipment. Critics
argued that then it could be too late, because the damage might already have occurred
(Valdimarsson, 1966; Gislason, 1966). However, the government was satisfied with
Alusuisse's responsibilities regarding pollution and environmental threats.
Another important issue regarding location choice concerned labour supply.
During most of the negotiation period, 1960-1965, there was a labour shortage in Iceland.
Yet it was estimated (Nordal, 1965c) that the construction of the power plant would need
300 workers in 1966, 340 workers in 1967 and 360 workers in 1968. In addition, the
aluminum plant needed 320 workers in 1967 and 530 workers in 1968. According to
Nordal(1965c) these figures are all maximum estimates. The total labour force needed for
both projects is 660 workers in 1967 and 890 workers in 1968, including foreign
technicians and specialists (Nordal, 1965~).Bearing in mind that the total labour force in
Iceland in 1966 was 77,000 workers the project required over 1% of the nation's labour
force (Rannsoknaraa Rikisins 1975). In Nordal(1965c) it is estimated that between 19651968 some 4,240 persons would be added to the labour force as a result of natural
increase. This means that the two projects would use the equivalent of around 20% of this
increase and if Straumsvik would be chosen as a location some projects at the NATO-base
at Keflavik International Airport, which is located 30 km from Straumsvik, could be
delayed by the government (see Figure 1.1 and 5.6) (Nordal, 1965~).In summary, it was
argued by the government that it would be easier to provide a sufficient labour force if the
smelter were located at Straumsvik which is located close to Iceland's largest city,
Reykjvik, and that would make it easier to meet labour requirements of both projects.
Straumsvik has a further advantage over Gaseyri as a location for the new
aluminum smelter in terms of hture expansion. Straumsvik, as mentioned earlier, is a open
space location and there are no constraints regarding further expansion of the new smelter
and Alusuisse in 1965 mentioned a possible enlargement, in the future, of the smelter to
120,000 ton. In addition, an aluminum smelter potentially opens up opportunities for the
hrther processing of aluminum. Nordal (1965~)and Hafstein (1965) argue that it is
important for industrial development to have access to materials and an aluminum smelter
would provide cheaper aluminum for Icelandic firms than the world market price, at least
the transportation cost and such industry could therefore be competitive. According to
TIDC (1963a) Alusuisse stated that it would be ready to help with the technical side of
such projects which might include manufacturing materials used in the construction
industry andlor cans for fishing products. Such projects would create additional jobs in the
hture (Nordal, 196%; TIDC, 1963a; Hafstein, 1965) and because it is necessary to build a
new harbour for an aluminum smelter there would be many advantages of locating such
new industries in close proximity (in the future) to the smelter. In 1964 the Icelandic
government agreed to Alusuisse's ideas that the government would provide the smelter
with harbour facilities. In the Master Agreement it is stated that the Municipality of
Hafnarfjorbur (Straumsvik is located in Hafnarfjorbur Municipality) will build the harbour
and provide the smelter with a site. In return, ISAL agreed to pay back the cost of the
harbour, in the form of harbour fees charged over a 25 year period, with 6 112% interest
(Icelandic Government and Alusuisse, 1966; Hafstein, l966b).
-Power Supply
During the two-year period of 1960-1962 the Icelandic government hired an
American engineering company (Harza Engineering) to look at possible Hydro-electric
sites. The two locations that were the most economically efficient were Burfell, on the
South coast, and Dettifoss on the North Eastern corner of the country (see Figure 1.1). It
should be repeated in this regard that, an aluminum smelter on the North coast implied
reliance on a power plant at Dettifoss, and an aluminum smelter on the South coast
implied reliance on a power plant at Burfell.
Harza Engineering provided TIDC with reports, in 1962, that Burfell is the
cheapest option for a new power plant and probably the best. In those reports it is argued
that the best size is a 105 MW plant that would be enlarged in three steps to a 210 MW
plant. To begin with a 30,000 ton aluminum smelter would use 55 MW and when the
smelter doubled in size, Iceland could enlarge the power plant simultaneously. Harza
Engineering also recommended that the price of power should be 2.8-2.9 mills per Kwh
or at least not lower than 2.5 mills per Kwh, otherwise the government would not be able
to justify the project (TIDC, 1963a). It should be noted that early in the negotiations it
became evident that the size of the proposed aluminum smelter would affect the
construction of a power plant. Originally, in 1960, Alusuisse argued that the proposed
smelter would be 20,000 ton but in 1961 Alusuisse argued that a 27,000 ton smelter
would be a better size. Subsequently, in 1962 TIDC asked Alusuisse if it would be
possible to enlarge the proposed aluminum smelter so it would use more of Burfell's
power production, and in 1963 Alusuisse argued that the optimum size had risen to
30,000 ton. A 30,000 ton smelter uses close to 55 MW. Later, or in 1965, Alusuisse still
wanted to build a larger smelter or a 60,000 ton.
TIDC (1962b) stated that the biggest problem facing the Dettifoss location was
that there is no other power plant on the North coast so it would be impossible to provide
electricity to an aluminum smelter, located on the North coast, if the Dettifoss plant would
fail for some reason over certain period of time. Critics argued that this was only used as
an excuse not to build the power plant on the North coast because the same problem
existed on the South coast as no existing power plant there was big enough to provide
electricity to an aluminum smelter. The National Power Company (Landsvirkjun) would
have to build an alternate gas-turbine power plant close to the site wherever the smelter
will be located. In the end, the fact that Burfell was a cheaper power source and
Straumsvik a cheaper site to build a smelter convinced Alusuisse and the Icelandic
government to go with the Straumsvik-Burfell option.
The location of the power plant was not the only concern in the negotiations. Price
of power and the financing of the power plant were also important issues. As mentioned
earlier, financial constraints prevented the government from constructing a large power
plant without power intensive industry. However, the World Bank stated that if the
Icelandic government makes a long term agreement of electrical sales to the proposed
aluminum smelter, it was ready to provide the capital as long as electricity price to the
smelter would be acceptable. Alusuisse had emphasized both in November 1961 and in
April 1962 that the electricity price should not be higher than 2.0 mills per KWh, but
according to Harza Engineering, in 1962, it was estimated that the price had to be 2.8-2.9
mills per KWh to make construction of a power plant economically possible (TIDC,
1962b).
At a meeting in Ziirich in September 1963 Alusuisse confirmed that, if an
agreement concerning electricity price and other unsolved matters could be reached, the
firm would be prepared to build a 30,000 ton aluminum smelter as soon as 1967-1968.
The smelter would not double in size for at least 5-8 years. The smelter could be smaller
to begin with if that would suit the government better, regarding construction of the
power plant. Alusuisse also informed the Icelandic negotiating committee that they could
not in any way provide Iceland with capital to build the power plant. The government had
asked for such financing earlier and had proposed they could pay back the loan through
sales of electricity (TIDC, 1963a). Because of these financial problems the government
had to examine other alternatives to finance the power plant and this search led the
government to contact the World Bank.
During the first half of 1964, TIDC and the Icelandic government worked on
negotiating with the World Bank in an effort to raise capital for the power plant. The
World Bank pointed out that fbrther negotiation between Iceland and Alusuisse should not
continue until they had finished their work regarding financing the power project (Nordal,
1964). In October, the World Bank finished their report about financing the Burfell power
plant. In a letter to Nordal (director of the Central Bank of Iceland and Chairman of
TIDC) from the World Bank it is stated;
"We have just completed our review of the Burfell power project, ........ We feel that the
project is large for an economy of the size of the Icelandic and would require a heavy
commitment of resources during the next Jive years while the beneJits to the economy
would be relatively modest. At the same time the project appears to be within the ability
of Iceland to undertake and we have taken note of the judgment you reached that no
other major investment in the public sector appeared to offer a more attractive
alternative and to contribute more to the diverslJication of the economy. We have there
fore concluded that the project would be economically justified if certain minimum
conditions are met." (Cope, 1964, pp. 1).
Cope (1964) states that the World Bank is ready to finance the Burfell power project if
'certain minimum' conditions are met. At that time, these minimum conditions were,
electricity prices not lower than 2.5 mills per Kwh and taxes at least 33% on net profits.
In this regard a net profit tax of 33% was equivalent to 1.2 mills per Kwh according to
Icelandic taxation laws so that the mix can be translated into a total cost of 3.7 mills per
Kwh (Cope, 1964).
"Considering that 2.5 US. mills per KWh would only cover the cost of supplying the
power to Alusuisse, we feel that a rate below this level would not justrh the capital
expenditures required for Burfell. Similarly, we feel that the 33% rate at which the net
profits of the smelter are taxable represents a reasonable level of taxation and that any
concessions granted to the smelter under this heading would represent a subsia which
would not be economically justified and which would Jirrther reduce the alreaa
relatively modest foreign exchange benefit to the economyfrom the project. We therefore
feel that payments by the smelter for power and taxes combined should not be below the
equivalent of 3.7 US. mills per KWh if the project is to be economically justfled. We
should also like to point out that, on the basis of international comparisons, both a rate
of 2.5 US. mills per KWh and a tax rate of 33% on net profits would be very favorable to
the smelter." (Cope, 1964, pp. 1-2).
After it became evident that the price of electricity would not be negotiated separately
fiom taxes, Alusuisse required, in 1964, that the price of power and taxes should be no
more than 3.2 mills per Kwh, otherwise the project would not be economically feasible
(Alusuisse, 1964b). These different views, World Bank's 3.7 mills and Alusuisse's 3.2
mills, were solved on a meeting in Ziirich in December 1964. In the final agreement after it
was decided that taxation of the smelter would be a fixed amount on each produced ton of
metal, all participating parties agreed that the proposed smelter would pay 3.0 mills per
KWh the first 6 years of operation. This price would after these 6 years be lowered to 2.5
mills per KWh (see appendix 1).
At a meeting in Washington in March 1965 Alusuisse argued that a 30,000 ton
smelter was no longer economically profitable. Instead they wanted to build a 60,000 ton
smelter which they argued is a more feasible size and the firm wanted to reserve the right
to enlarge that smelter. This meant that the Icelandic government would have to build the
Burfell power plant faster than originally intended. The World Bank agreed to finance the
project faster if Alusuisse would sign an agreement that would guarantee purchase of
electricity for a 60,000 ton smelter. At the meeting all parties agreed that Alusuisse would
first build a 30,000 ton smelter which would be enlarged to 45,000 ton after 3 years and
then to 60,000 ton after another 3 years. The agreement should be open to the possibility
of enlarging the smelter faster than this (Nordal, et al., 1965).
In the final agreement Alusuisse agreed to pay a higher electricity price during the
first 6 years of operation, instead the smelter would pay lower taxes. Alusuisse would pay
3 mills per KWh the first 6 years and after that the price would drop to 2.5 mills per Kwh
and taxes would be raised at the same time (Icelandic Government and Alusuisse, 1966;
Hafstein, 1966b). It was agreed that the power agreement should be revised after 15 years.
According to the Agreement electricity price can also change if, for example, there would
be a great price increase on aluminum at the world market, and/or if prices changed
elsewhere in places where Alusuisse owns aluminum smelters, for example, in Norway or
Tennessee.
Taxation
k
At the beginning of the negotiation the Icelandic negotiators emphasized that the
new smelter should be taxed as other Icelandic firms. However, the government would
make exceptions in the case of double taxation, that is the government agreed to change
its laws when taxing the same revenues as the home country of Alusuisse, Switzerland.
The government also emphasized that the proposed smelter would be provided with the
best possible depreciation options allowed according to Icelandic laws (TIDC, 1962a).
At a meeting in Reykjavik in November 1963 the two parties agreed that the price
of electricity would be 2.5 mills per KWh and because of this higher electricity price, than
the original 2.0 mills anticipated by Alusuisse, that taxes should be levied in accordance
with a simple formula involving fixed amount per ton of metal sold. An idea for this
formula was also put forward:
2000((A-B)t 0.8 C)
where:
A = world market price in U.S. cents per lbs. of virgin metal in pig form.
B = estimated gross cost price in U.S. cents per lbs. of virgin metal in pig form.
t = normal rate of total taxes in Iceland under existing tax laws expressed as a
proportion of gross profits (A-B).
c = the difference between the agreed power price in U.S. cents per KWh and the
base cost of 0.2 cents per KWh.
This formula was to apply as long as 'A' does not increase or decrease by more than an
amount to be agreed upon (TIDC, 1963a).
In November 1965 the parties were still debating taxes and at a meeting in Ziirich
both parties agreed upon a tax formula (see Table 4.5). According to the Master
Agreement ISAL pays US$ 12.5 on each produced ton the first six years of operation,
during that time ISAL would finish depreciating the smelter, then US$20 for the next nine
years. After these 15 years taxes on each produced ton of metal will rise to US$ 35
(Icelandic Government and Alusuisse, 1966; Hafstein, 1966b). They also agreed, in 1965,
on a maximum and minimum tax. In particular, they agreed that a minimum tax on a
60,000 ton smelter should never be lower than US$ 200,000 annually, and maximum tax
should never be higher than 50% of net profits. In addition, both parties agreed that the
agreement for taxes should be revised after certain period of time, first after 22 years, and
thereafter every 10 years (Nordal, et al. 1965).
One of the main reason why the government focused on fixed taxes was because
Alusuisse owns all three aluminum production stages, Alusuisse sells the alumina to ISAL
and the firm buys the primary aluminum from ISAL. The firm potentially has an
opportunity to decide where profits should be shown, for tax purposes. By bargaining for
fixed taxes the government has guaranteed a certain income through taxation (Jonsson,
1965). Though US$ 20 seems low for each produced ton it will rise very fast if the price
of primary aluminum rises, for example, if world market aluminum prices go up 25% taxes
will rise 125%, from US$ 20 to US$ 45 (Hafstein, 1966b). For support of this taxation
method the government contacted specialists in many countries to ask if this new method
of taxation is appropriate. All these specialists agree that this tax formula is in the favour
of the government (Grondal, 1966). In Norway, where they do not use a fixed tax, there
are a few aluminum smelters and the highest tax the Norwegian government has achieved
is US$ 18.5 per produced ton (Hafstein, 1966b).
TABLE 4.5
TAX FORMULA
Tax Formula
1) Base Minimum Tax. For the whole 25 year contract period a base minimum tax of $20 per ton of
Aluminum delivered will be payable. If the world market price changes from 24.5 cents per pound, this
base minimum tax will change proportionately upwards or downwards.
2) Annual Accounts. ISAL will submit to the Government annual accounts prepared by independent
auditors of their own choosing. The Government will have the right to appoint at its own expense an
international firm of chartered accountants to check the accounts and carry out such examinations of the
books of ISAL as they deem necessary.
3) Consolidated Tau. A consolidated h~of 33 113% of net profits of ISAL will be calculated in U.S.
dollars for every calendar year of operation. This will be operative as follows:
A. During first 15 years of operation.
If the consolidated tax during any year is below the base minimum tax actually levied, a tax
credit will accrue in favor of ISAL. If, conversely, the consolidated tax is higher than the base minimum
tax, then ISAL will assume a tax liability equal to the difference. The net k u credit or liability of ISAL at
the end of the 15 year period will be carried over to the following 10 years as follows:
a) If there is a tax credit, this will be deductible from consolidated tax in equal annual amounts
over this period.
b) If there is a tax liability, this will become payable in equal installments over the period in
addition to normal taxation according to B. below.
5% interest p.a. will accrue on outstanding tax credits or liabilities. Tax balances will be
expressed in U.S. dollars.
B. During last 10 years the consolidated tax will be levied every year plus or minus the tax carry-over,
including interest, from the first 15 year period, always subject to the minimum of $20 per ton of
Aluminum delivered.
C. If there is a tax credit in favor of ISAL at the end of the 25 years, this will be set against taxation in the
subsequent 10 year period.
(Nordal, 1965b).
Import Duties
It is stated in a TIDC (1962b) report that import duties are much higher in Iceland
than in most other countries. Also, the report noted that there are import duties, in
Iceland, on all kinds of things used in industries, such as machinery and materials, which
have no import duties in other countries. This makes the country a less attractive location
for MNCs. In an effort to continue negotiations in 1962, TIDC emphasized that the
government would promise Alusuisse that regulations and laws regarding import duties
for the aluminum industry, specifically concerning machinery and raw materials, would
change. This is common in countries that are competing with Iceland as a location options
for the aluminum industry, for example Norway and Ghana. Another possibility regarding
imports was to establish a 'Duty Free Zone'. The aluminum plant would then be build
within this zone. Whether the new smelter would be built in a duty free zone or not the
government promised, in 1962, that import duties would not be an obstacle for the new
smelter (TIDC, 1962a; 1962b).
Legal Issues
At a meeting in April 1962, the 'safety' of the investment was first mentioned. The
term safety refers to the possibility that foreign investment could be overtaken, at any
time, by the Icelandic government. The Icelandic government had never negotiated with a
foreign company before so the government had no former experience in such matter
(TIDC, 1962b; Nordal, 1994). Another legal issue that was not anticipated by either party
at the beginning of the negotiation, was that ISAL is an Icelandic firm but will have
exemptions from Icelandic laws. It will be 100% foreign owned (Alusuisse), and it will not
be under Icelandic jurisdiction. If disagreements arise between the government and I S M
an international court of arbitration will have the final verdict. This judicatory is though
supposed to use Icelandic laws (Icelandic Government and Alusuisse, 1966; Josefsson,
1966). This debate surfaced rather late in the negotiations. Originally it started because
Alusuisse's lawyers argued that Iceland did not have internationally recognized laws,
concerning foreign investment, so that it would be impossible to solve disagreements only
with regard to Icelandic laws (Icelandic Government and Alusuisse, 1966; Nordal, 1994).
In October 1965 this issue almost became an irresolvable conflict. Alusuisse argued that
the court of arbitration should not use only Icelandic laws. The government then gave
Alusuisse an ultimatum, only Icelandic laws or the government would drop the project.
After one day of consideration Alusuisse agreed that an international court of arbitration
would only use Icelandic laws and the negotiation could continue (Hafstein, 1966b). This
way of solving problems in the world, that is using an international court of arbitration, is
used more and more. Conflicts between nations are most often solved in another country
and Iceland has made such an agreement before with other countries. Iceland has also
made such an agreement with foreign companies, for example a Soviet Union oil company
(Hafstein, 1966b).
Though the Icelandic negotiating committee could force Alusuisse to agree upon
using Icelandic laws, this issue was criticized fiercely in the Icelandic Parliament. Josefsson
(1966), among other members of the Parliament, argued that ISAL is an Icelandic firm,
and disagreements should be solved in Icelandic courts. The Icelandic negotiators argued
that this is the first time a MNC enters Iceland and Icelandic courts do not have any
experience dealing with such matters so it is best that an international court of arbitration
will solve these matters but in doing so use Icelandic laws. Critics, however, did not agree
and argued that it is strange that people (judges) which do not understand the language
nor know the laws, are supposed to interpret both (Josefsson, 1966; Gislason, 1966).
"lf the government does not trust Icelandic judges why don't they settle all cases abroad.
Even Hew Meyer (Alusuisse Director) said in interviews with the Icelandic press that
'this was the first time that Alusuisse has negotiated something like this'." (Jkfsson, 1966,
pp. 1400).
This way of settling disagreements, between Alusuisse and Iceland, was first used
when construction at the harbour site began and it became evident that the construction
cost would be higher than estimated because of inefficient research. ISAL was then judged
to pay the contractor compensation for the extra cost (Halldorsson, 1994).
Duration of the Master Agreement
Another conflict, concerning the duration of the Master Agreement, arose late in
the negotiations. Alusuisse emphasized that the Agreement should have the duration of 50
years (Alusuisse, 1964~).The Icelandic government, on the other hand, emphasized that
the agreement should only have the duration of 25 years and that both parties would be
able to extent that time for another 10 years which means that the scope of the agreement
would be 45 years (Olgeirsson, 1966; Jonsson, 1965). At the end Alusuisse agreed to the
terms of the Icelandic government (Icelandic government and Alusuisse, 1966).
Critics (Olgeirsson, 1966; Josefsson, 1966; Jonsson, 1966; Valdimarsson, 1966;
Kjartansson, 1965; Arnalds, 1966) argued that the duration of the Master Agreement was
far too long, and if the government was going to tie the nation for 45 years the least it
could do is to have a national referendum about the Master Agreement.
rev is in^ the Bargain
As can be seen from the above discussion Contreras and Gregersen's (1975)
framework (Figure 2.3) has been adjusted to fit the purpose of this thesis. At the beginning
of the chapter it was argued that all 'conflicts' became negotiable as the smelter was built.
However, the framework does not explain why Iceland was chosen as a location nor how
a location within the country was chosen. Also, in practice, the idea of 'minimum
requirements' was more relevant, or at least specified, in the case of Alusuisse than the
Icelandic government. This implies that the outcome of the bargaining process does not
rely only on minimum requirements as the framework indicates. In addition, it should be
noted that a HC is not the same as the HCG. The HCG is usually the negotiator for the
HC but the HCG does not represent all interest groups and there are also opposing views,
for example, in the Parliament and in the this case the Icelandic government got the
Parliament's approval of the Master Agreement with the margin of one vote.
The bargaining process, outlined in this chapter, created location conditions that
made Iceland a desirable location for power intensive industry, in particular the aluminum
industry. Kirchner (1988) describes this well when discussing the evolution of the
aluminum industry in Western Europe:
"The Iceland story is the simplest. The country had considerable hydropower capacity,
and in 1966 it offered Alusuisse low electricity rates for ji'fteen years to encourage the
company to build a smelter there. Alusuisse built a relatively small smelter... and
Alusuisse took all the production ?om the smelter to serve its customers. @'%enthe
fifteen-year initial power contract expired in the early 1980s, the Icelandic government
sought to raise its electricity price to the smelter signzficantly.... Alusuisse resisted the
increase and threatened to close the smelter, setting off considerable political
controversy. A new compromise rate wasfinally negotiated,..." Wrchner, 1988, pp. 72).
As Kirchner (1988) indicates the Master Agreement was rendered obsolete particularly in
regards to the power contract. It set off a considerable debate during the late 1970s but
especially at the beginning of the 1980s. Due to changes in the global energy environment
(such as the two oil shocks) the power agreement had to be revised sooner than
anticipated and because of these changes the electricity price never did go below 3.0 mills
per Kwh. Changes in the world energy environment affected the agreement and instead of
dropping, the price of electricity kept rising (Nordal, 1994). In 1975, when the power
agreement was first revised, the price of electricity had already tripled. The power
agreement was again under pressure in 1980, but was not revised until 1984 (Halldorsson,
1994). During the first half of the 1980s the Master Agreement was revised as a whole.
The most important change that was made was to tie together power price and aluminum
price. Nordal (1994) argues that Iceland was a pioneer in doing this and today this is
common in most Master Agreements between governments and aluminum MNCs.
Halldbrsson (1994) argues that if the debate during the late 1970s and early 1980s had not
come up, Alusuisse would have asked for an enlargement of the ISAL smelter in 19821983. It should be noted that Alusuisse did not ask for an enlargement in 1983 when a
'more fiiendly government' took power and negotiated a new power agreement. The
ISAL smelter, however, has enlarged during the last 25 years. The smelter was originally
built as a 30.000 ton smelter then enlarged first to 44,000 ton in 1970, to 77,000 ton in
1972, to 88,000 ton in 1980 (Ianaaarratineytib, 1991a), and finally to 96,000 ton in 1993
(Palsson, 1993).
Though location conditions that Alusuisse negotiated seemed favourable, another
problem, apart from the power contract, surfaced shortly after the Master Agreement was
approved. The problem was the basis of the firm's relation with labour unions. There were
10 unions involved. They all fought for their own rights. They realized quickly that the
smelter would have to operate 24 hours a day, every day of the year, and that the smelter
could not stop for any reason because it would be so expensive. Therefore the unions
realized that they would have more bargaining power because the smelter could not afford
a strike by one union and by threatening a strike they could ask for higher contract
improvements than the domestic labour force generally received. After negotiations began
between ISAL and labour unions, ISAL argued early that it would be difficult to negotiate
with 10 different unions and that it would be in the best interest, especially for the smelter,
that the unions in question would agree on one negotiation party on their behalf The
unions disagreed and argued that they would lose most of their bargaining power if they
agreed to ISAL's ideas. This situation became a big debate, but after one year of
negotiations, between 1968-1969, the unions agreed to create one negotiation party for all
the unions (ISAL, 1979; Halldorsson, 1994).
Though some problems surfaced after the Master Agreement was signed, it seems
that most people agree that the agreement reached with Alusuisse in 1966 was a good
agreement for the nation.
CHAPTER V
THE BARGAINING PROCESS BETWEEN THE
ICELANDIC GOVERNMENT AND THE ATLANTALGROUP
Introduction
This chapter examines the negotiations between the Icelandic government and the
ATLANTAL-group, a joint venture of three (originally four) aluminum multinational
corporations (MNCs), between 1987-1991. These negotiations are again analyzed within
the frameworks of the bargaining process outlined in chapter 2, in particular the model
developed by Contreras and Gregersen (1975).
Before examining the actual bargaining process the main outcome of the
negotiations is outlined, including a chronology of events (Table 5.1). Then the context
within which the negotiations occurred is briefly introduced and after that discussion, the
motivation factors for both the ATLANTALgroup and the Icelandic government, and
situations where there is 'conflict' andlor 'no conflicty in motivation, are identified.
Though the plant has not yet been established all 'conflictsy, such as location, taxes, and
price of power, situations were 'negotiable' (see Figure 2.3). Conditions in the rest of the
world created an environment which made it impossible for both parties, especially the
ATLANTAL-group, to sign a Master Agreement, though both parties had reached a
'negotiable situation'. In conclusion, there is a discussion examining the delay of the
ATLANTAL project and whether the smelter will ever be erected.
The ATLANTAL-group and the Icelandic government were not the only
participating parties in the negotiations. Local governments in Iceland affected the
negotiations, especially regarding the location of the proposed smelter, and the debate
over regional policies and environmental issues also affected the negotiations. In addition,
the ATLANTAL-group changed during the negotiation period. The so-called
ATLANTAL-group was originally established in 1987, with the purpose of building an
aluminum smelter in Iceland, and consisted of four aluminum MNCs, Alusuisse (see
Chapter 4), Granges AB (from Sweden), Hoogovens Aluminium BV (from Holland) and
Austria Metal1 (from Austria). During 1989 two firms dropped out (Alusuisse and Austria
Metall) and in 1990 one new aluminum MNC joined the group (Alumax) (see Table 5.1
and 5.2). Granges and Hoogovens emphasized that the project would have to be a joint
venture as they were not capable of building the proposed smelter alone. The advantages
for aluminum MNCs engaging in joint ventures are many, for example to spread the risk
and make financing of projects easier (see Chapter 3).
The Bargain: Key Elements
Though the negotiations were not completed with the signing of a Master
Agreement and the smelter has not been built, the two parties reached a preliminary
agreement which includes agreement on most important issues. This section will list the
main outcome of the preliminary agreement reached through negotiations between the
ATLANTAL-group and the Icelandic government between 1987-1991 (see Table 5.1 for
chronology of events).
According to the preliminary agreement, the proposed smelter is supposed to have
210,000 ton annual production capacity and will be located at Keilisnes in the Reykjanes
region (see Figure 5.1 and 5.6) and is to be provided with energy from the Blanda power
plant (Figure 5.1) and other, yet to be constructed, power plants. In the preliminary
agreement the price of power is calculated as a certain percentage of the price of
aluminum with a certain minimum and maximum charge. The power agreement is
supposed to be for 25 years with the smelter having the option to extend the contract
period by two additional five year periods.
According to the preliminary agreement, the proposed smelter will be taxed
pursuant to Icelandic law although there will be some exceptions because of its size and
specialization. Disputes, between the parties, are supposed to be settled by Icelandic
courts pursuing Icelandic laws.
The proposed smelter is planned to operate as a tolling smelter and therefore does
not have to pay import duties.
Duration of the Master Agreement will probably be the same as for the power
agreement.
This agreement was reached after intense negotiations between the Icelandic
government and the ATLANTAL-group between 1987-1991. Table 5.1 shows the
chronology of events during this negotiation period. Before describing the interactions
between the Icelandic government and the ATLANTAL-group the next section discusses
the context within which the negotiations occurred.
Context
This section briefly examines the Iceland's and the corporate context for the
negotiations of the proposed smelter. In particular, it identifies debates in Iceland in the
mid-1980s regarding foreign ownership, especially regarding the aluminum industry, and
other issues, such as environmental issues and development of the Hydro-electrical
resource, that provided influential background to the negotiations between the
ATLANTAL-group and the Icelandic government. In addition, the ATLANTAL-group
context for the negotiations is introduced.
Iceland
During 1969-1987 the debate within Iceland regarding power intensive industry, in
particular the aluminum industry, changed. After Alusuisse erected the ISAL aluminum
smelter in 1969 the opposition to foreign investment and the fright over foreign control, in
Iceland, declined. As has been described before, there was a fierce debate regarding
foreign ownership and foreign control in Iceland prior and during the negotiations with
Alusuisse 1961-1966 (Chapter 4). Though these issues were still relevant, other issues
notably regional development and environmental issues had become more important in
relations with the fbture development of the energy resource in Iceland.
TABLE 5.1
OF
EVENTS
DURING
THE NEGOTIATIONS BETWEEN THE
CRONOLOGY
ICELANDIC GOVERNMENT AND THE ATLANTAL-GROUP 1987-1994
Date or Period
During 1987:
Comments:
Formal discussions begin behveen the Icelandic government and the ATLANTALgroup.
Parties reach a preliminary agreement to enlarge the ISAL smelter in Straumsvik.
June 1988:
It became evident that there were different views within the ATLANTAL-group and
In 1989:
Alusuisse dropped out of the group because the other firms wanted to build a new
smelter, not enlarge ISAL.
September 1989: Austria Metal1 dropped out of the group.
February 1990: Alumax joins the group (and soon becomes the leader).
March 1990:
Both parties sign a declaration of intent. Negotiation shall finish within a year and
operation of a new smelter shall start in 1994.
June 1990:
Both party's emphasis is on the location rvithln Iceland.
October 1990: Keilisnes is chosen as a location for the new smelter. Both parties agree that the new
smelter would be taxed pursuant to Icelandic laws and that electricity price would be
calculated as a percentage of aluminum price. Also that the smelter would be a tolling
smelter and does therefore not have to pay import duties.
November 1990: Negotiations mostly finished and it was agreed that a Master Agreement should be
signed no later than February 1991.
February 1991: Negotiations have delayed because of the Gulf War and because aluminum prices have
fallen rapidly.
August 1991: Negotiation progress slowly because the ATLANTAL companies can't raise capital
to finance the project. Signing of the Master Agreement postponed until March 1992.
November 1991: Negotiation finished, but it came evident that the project had to be postponed longer
because of the capital constraints.
1994:
Both parties still willing to pursue with the project but conditions in rest of the world
make the project economically impossible.
Also, between 1969 and 1987 a few small power intensive companies were established in
Iceland, notably a Ferro silicon smelter at Grundartanga and a diatomite processing
factory at M*atn
(see Figure 5.1). These new plants were jointly owned by the Icelandic
government and MNCs and were located outside the Greater Reykjavik area. However,
during this period aluminum production was commonly considered by the government as
the optimum choice for fbture development of power intensive industry in the country.
During 1987 the possibility of a new aluminum smelter became real and the debate
about power intensive industry and power plants surfaced again in Iceland
(IBnaBarraBneytib, 1988; MorgunblaBib, 1987). At a conference about power intensive
industry in November 1987, Zoega (1987) argued that the government's policy should
stay unchanged and that Icelanders should own and control resources located in the
country and allow foreigners to own power intensive companies. By following this policy
the nation could avoid the risk of operating such companies. Instead, Icelandic industrial
companies should focus on semi-finished or finished production, for example, value added
aluminum industry. The government believed that there were many opportunities for value
added production utilizing aluminum although in 1987 Icelandic firms only used 200 tons,
of the 85,000 tons that were produced at ISAL, principally in the production of pots and
pans.
Nordal (1987) argued that the only possibility in attracting power intensive MNCs
is to provide them with energy at a competitive price. He argued that Canada and
Venezuela are selling their energy cheaper than the cost of production in an effort to
attract power intensive industry, but the cost of energy production in Iceland is still lower
than the price they are offering.
Apart from the price of power, two other issues created special attention in
discussions concerning the attraction of aluminum MNCs to Iceland, first, environmental
issues, and second, the debate about location within Iceland.
Until 1980, when standards for the aluminum smelter were first set, ISAL did not
use any kind of emission control. After that the smelter was allowed to release a maximum
of 1.5 kg of fluorides per ton of primary aluminum produced. During the 1980s the
regulatory situation in Iceland was similar to that of the other Nordic countries in that
emission standards were not fixed or prescribed. Each case was evaluated separately and
an optimal solution sought according to 'best practicable means'. Several observers
argued, however, that a new aluminum smelter would probably at least have to meet the
United States New Source Performance Standard which would mean that the new smelter
would be allowed to release no more than 1 kg of fluorides per ton of aluminum produced
(96-97% removal) (Guttormsson, 1987; Einarsdottir, 1988; 16naTlarridneyti6, 1986).
Einarsdottir (1988) argues that stricter standards are needed for pollution, particularly
with respect to ground water pollution and sulfur dioxide pollution. According to
Einarsdottir (1988) the threat of environmental pollution and damage is far greater than
the benefits from a new aluminum smelter. She also argues that pollution and
environmental damages can affect another growing industry, the tourism industry.
Valgeirsson (1990) notes that since Iceland has been trying to attract tourists to the
country by advertising that the country is one of the cleanest in the world it is strange that
the government is also attracting aluminum firms to locate in the country which do not
have to install the best pollution equipment available for such an industry. Valgeirsson
(1990) continues and points out that the country should rather focus on power intensive
industry that does not pollute as much as an aluminum smelter, for example, hydrogen
production. The government argued that the proposed smelter would probably have to
install the best pollution equipment available (Nordal, 1994). However, the government
indicated that there could be some difference between locations and therefore a possibility
that there will be different requirements for different locations.
During the late 1970s and the 1980s there was an increasing emphasis by the
Icelandic government on regional development. As a result, it has been argued, that the
government's goal for the location of the new proposed aluminum smelter and the hture
development of the power resources would compliment regional development policies
(Morgunbla8i6, 1988). During the 1980s regional development policies focused on
creating jobs in rural areas, in effect any where else other than close to the Greater
Reykjavik area. However, supporters of the aluminum industry in Iceland argued that the
government could not require a certain location within the country because the aluminum
industry is so competitive and the MNC must be able to locate at the cheapest possible
option or where it wants to locate (Morgunblabib, 1989).
"Political preferences cannot determine the location, of the proposed smelter, within
Iceland. MNCs that are prepared to provide capital in business activity in Iceland will, of
course, want to choose the location that is the most feasible from art economical
viewpoint." (Sigurbsson,1989, pp. 16).
There were other important issues. The experience and the learning process of the
negotiations with Alusuisse (see Chapter 4) and the experience of ISAL, made these more
recent negotiations easier for the government. Issues such as, special tax agreements,
resolution to conflicts and import duties no longer needed extensive deliberation. The
ATLANTAL project was also compared to the ISAL project to show that the government
could handle such a project. This comparison shows that the investment of the
ATLANTAL project, as a ratio to total investment in Iceland is 31% which is only 4%
higher than the ratio for the ISAL project and that total labour force needed for the
ATLANTAL project, as a ratio of total labour force in Iceland is only 1.4% which is
almost 1% less than the same ratio for the ISAL project. It should be mentioned that both
figures are peak estimates for the project.
The government had also been focusing on changing the business environment
within the country to make it more accessible for foreign direct investment. Entry barriers
such as the complicated tax system and restrictions on foreign exchange transactions were
been reduced or eliminated during the 1980s (Sigurbsson, 1994). This has made the
country more comparable to other Western countries. As part of this strategy, the
government specifically sought to make the country a more attractive destination for
aluminum M K S . Studies by Stabarvalsnefhd um ibnrekstur (1983); (1986);
GuBmundsson and Boasson (1988); ReybarfjorBur district (1992); IiSnabarrabneytiij
(1990); (1991a); Industrial Development Corporation of Eyjafjorbur (1990) also prepared
the government better to engage in negotiations with big MNCs.
As in the negotiations with Alusuisse, the optimum goal in attracting power
intensive industries to Iceland for the Icelandic government is to get adequate revenues for
the sales of electricity. However, during the late 1980s and early 1990s another option to
utilize the energy resource, other than power intensive industry, considered by the
government was, and still is, to export electricity directly to Europe. Technical innovations
during the last decades have made this strategy possible and some observers noted that an
advantages to be gained by using the energy resource this way is that no polluting
industries would have to be built (Gestsson, 1991). This idea has been referred to as
'LSD' ('Landsins Stzrsti Draumur', e. (the nation's) Largest Size Dream). The idea was,
and has been, widely criticized, however, on the basis of the argument that by exporting all
the energy there would be no (long term) job creation in the country, only short term jobs
while the construction of power plants is ongoing. Another point raised by the critics of
direct exports of electricity to Europe is that it must be in such huge quantity that the
nation could hardly finance such a mass construction of power plants simultaneously
(~lafsson,1993). At the present time, the export option is still in the research stage and
the country's focus to utilize the energy resource is on attracting power intensive MNCs
to locate in Iceland.
The A TUNTAL-Group
ISAL was originally built as a 30,000 ton smelter in 1969. Since then its
production capacity has been increased a few times without any major construction of new
facilities (see chapter 4). However, in 1987 the ATLANTAL-group originally intended to
enlarge the ISAL smelter in Straumsvik. The idea about enlarging the ISAL smelter had
been discussed earlier and Halldorsson (1994) argues that Alusuisse would have enlarged
the smelter between 1982-1983 if the controversy within Iceland, regarding the firm's
electricity price, would not have surfaced in the late 1970s and early 1980s (see Chapter
4). In 1987, this idea to enlarge the smelter surfaced again, this time among Alusuisse and
three other aluminum MNCs, Granges, Hoogovens, and Austria Metal1 whose plan was to
establish a joint venture smelter located beside ISAL which could use the same facilities,
notably the harbour.
At this time aluminum prices were rising fast (see Figure 3.2) and aluminum firms
were expanding and increasing their production. However, in 1989 when it became
evident that Granges and Hoogovens did not want to enlarge ISAL but rather build a new
smelter, Alusuisse dropped out of the project. There were two main related reasons why
Alusuisse did not want to participate in building a new smelter. First, during the 1980s,
Alusuisse was reducing its production of primary aluminum and was closing smelters in
Austria, Switzerland, Italy, and Germany; and second, the firm was diversifLing into other
industries (see Table 4.2) (Halldorsson, 1994). Due to financial constraints Austria Metal1
also dropped out of the group in 1989.
The decisions of Alusuisse and Austria Metal1 did not affect the other two firms
which started looking for a new partner(s). The negotiations between 1987-1989 were so
promising that the firms were convinced that Iceland was, at this time, the optimum
location option for a new aluminum smelter and after Alumax joined the group in 1990,
negotiations with the Icelandic government began again. The ATLANTAL-group's
announced intention at that time, if the group could reach an agreement with the Icelandic
government, was to build a new 210.000 ton aluminum smelter.
Obiectives and Motivation Factors
As the section above, this section is also divided into two. The first part examines
objectives and motivation factors for the Icelandic government and the second part for the
ATLANTAL-group.
Icelandic government
The government objectives and motivation factors were, in general, the same as
they were 25 years previously. In general terms, the most important issue was to
strengthen the country's economic structure. Other important objectives were (and are);
the creation of new jobs, it was estimated that during the construction phase (1991-1994)
5,000 workers would be needed (Albingi, 1991a); to increase foreign income; to fbrther
develop the water resource (power production); and to promote economic development
(SigurBsson, 1994; Nordal, 1994). Sigurbsson (1994) argues that an important benefit
arising form foreign investment is that capital will immediately flow to the host country
(HC)and into its economy and, according to him, such capital does not increase the host
economy's foreign debt, which might be true in the short run.
"The ultimate goal is very simple, to increase the nation's income fo~nciirtions'~
(Sigurbsson, 1994).
Prior to the negotiations, the importance of regional development in connection to
power intensive industry had been emphasized. However, the government did not set
forward any requirements with regard to the location of the smelter within Iceland when
negotiations with the ATLANTAL-group began. The primary emphasis was to attract an
aluminum smelter to Iceland, so the location within Iceland was a secondary albeit
important consideration. The government's minimum goal is that any new power intensive
industry should at least pay for the marginal cost of the power production. Power sales
and taxes are the main sources of income from aluminum smelters in Iceland. Therefore
the government wanted to reach an agreement which would provide the economy with
certain income through power sales and taxation.
A TLANTAL-group
Cheap energy has been the main attraction for MNCs, including the ATLANTALgroup, to locate in Iceland. Other secondary important factors to the ATLANTAL-group
were political and economic stability while in subsequent negotiations Iceland's situation
in relation to Europe was mentioned as an important factor, specifically after Alumax
joined the group (Table 5.2) and became the leader of the group. For the American firm,
ties to Europe and the economic agreements that Iceland had made with other European
countries were of the utmost importance principally because there are no tariffs on primary
aluminum produced in Iceland entering Europe but there is a 6% tariff on aluminum
imported from the U.S. (SigurBsson, 1994).
For the ATLANTAL-group, energy was the main attraction for its investment
plans in Iceland. Iceland is one of the few developed countries with a surplus of renewable
energy from geo-thermal and Hydro-electric resources. This source of power offers
numerous advantages notably that it is environmentally acceptable, it can be incrementally
and progressively developed at competitive costs, and the risk of escalation in fbel prices
does not exist because it is natural and renewable. These characteristics are what attracts
power intensive industry to the country (Nordal, 1994; Sigurhon, 1984; Evans, 1993).
Energy is not the only reason why the group examined Iceland as a location
option. Evans (1993) (President & CEO of Alumax, until May 1994) argues that Iceland is
a preferred location for the group on the basis of assessment of political and economic
risk. The country is developed with practically 100% literacy rates, high longevity, and a
good communications network. The rule of law has been upheld in the country for a
thousand years. The sanctity of contracts is held in high regard. Evans (1993) continues, if
you make a deal in Iceland, you have a deal, and commitments will be honored.
"lf future
contract interpretation or dispute resolution is required we (Alummc) have
confidence it will be done in a way that is impartial and just to all parties. This is
extremely important when large capital investments are involved There are some other
advantages to locating high capital, high energy demand industry in Iceland. Most of
these projects involve a high level of automation and systems sophistication. People are
vely well educated. And, where necessary, can be easily trained.... When local resources
are fully employed or not available, suitable arrangements for foreign labour and
materials importation can be obtained.... While the country may seem remote, year-round
transport is available. Iceland is in good proximity to North America and Europe. n r e e
or four days by sea is much the same as coast-to-coast trucking in the US." (Evans, 1993,
P P 3-41.
These are the conditions that the ATLANTAL-group is looking for, and if the group can
reach an agreement, concerning price of power, taxation, and other important issues, with
the Icelandic government the group will erect a new smelter in Iceland.
TABLE 5.2
ALUMAX - SELECTED CHARACTERISTICS
7
Date or Period
1973:
Comments:
Alumax was incorporated in Delaware as Demax Realty Co. and operated as a joint
venture principally between AMAX Inc. and Mitsui & Co., Ltd.
1975:
Present name was adopted.
1986:
AMAX acquired the remaining 50% in Alumax Inc. (AMAXwas incorporated in New
York in 1887 as The American Metal Co., Ltd. The name was changed to American
Metal Climax Inc. in 1957. The present name was adopted in 1974).
Current status: The firm is engaged in the production and sale of primary aluminum, semi-fabricated
products such as sheet, plate, extrusion and foil, and diverse fabricated products. The
corporation operates in two business segments: Primary and Semi-fabricated Products,
and Fabricated Products. The firm operates over 100 plants and other facilities in 30
states, Canada and Western Europe. The most recent Alumax project was the
construction of a primary aluminum reduction plant in Quebec which began operation in
1990, the so-called 'Laurelco Proiect'.
(Moody's Investor Service, 1993b; 1993c).
Interactions between the ATLANTAL-Group and the
Icelandic Government
During the summer of 1987 formal negotiations started between the Icelandic
government and the ATLANTAL-group. Two possibilities were discussed; first,
expansion of the ISAL aluminum smelter; or second, building a new aluminum smelter in
Iceland (Nordal, 1994).
In June 1988 the Icelandic government reached a preliminary agreement with the
ATLANTAL-group to expand Alusuisse's aluminum smelter, ISAL, in Straumsvik
(IBnaBarraBneytia, 1990). This was supposed to be a new firm that would be built beside
ISAL but the firms would share existing facilities, such as the harbour (16naBarraBneytit5,
1988). However, between June 1988 and December 1989 a conflict arose within the
ATLANTAL-group. Two of the three ATLANTAL companies, Hoogovens and Granges
decided they wanted to build a new 200,000 ton aluminum smelter but Alusuisse did not
want to participate in such a venture. In addition, Austria Metal1 decided to quit the
project in September 1989, because of financial problems. Alusuisse's intention had been
to enlarge ISAL, not to build a new smelter (Albingi, 1990). Alusuisse was diversifying
*
and was focusing on semi-finished and finished aluminum production rather than
increasing its primary aluminum production. In the late 1980s the firm considered Iceland
as the optimum location for primary aluminum production, however, Alusuisse was not
prepared to participate in such a huge project as a new 200,000 ton aluminum smelter is
(Table 4.2).
Alusuisse's decision to drop the project did not affect the two other firms and they
decided to look for a new partner(s) to participate in erecting a new aluminum smelter in
Iceland (Allpingi, 1990). One of the first MNCs that the ATLANTAL-group contacted
was Alumax (American Metal Climax (AMC), see Chapter 4 and Table 5.2). The firm had
shown interest earlier in erecting an aluminum smelter in Iceland (Chapter 4), and after
two meetings, first in January 1990 and then again in February 1990, Alumax decided to
join the ATLANTAL-group and continue negotiations with the Icelandic government with
the purpose of building a new 200,000 ton aluminum smelter (Alpingi, 1990).
Shortly after this turbulent start, it became evident that the motivation factors and
objectives of both parties were mostly complimentary and both parties were eager to meet
and begin discussing matters in more detail.
In March 1990 the Icelandic government and the ATLANTAL-group signed a
declaration of intent which stated that the parties will finish negotiations within a year, and
the smelter will start production in 1994. The ATLANTAL-group would own the smelter
and each firm will own stock as follows:
1) Alumax
30-40%
2) Granges
25-35%
3) Hoogovens Aluminium
25-30%
It is also stated in this declaration of intent that the ATLANTAL-group and the
Icelandic government would adopt the following agenda to guide the negotiations: the
location of the smelter to be decided before the end of May 1990; all negotiations to be
finished before September 20, 1990; the government will try to get confirmation of the
Master Agreement, in the Parliament, before end of 1990; and, the ATLANTAL
companies will try to get confirmation fiom their boards of directors before end of 1990
(Albingi, 1990).
After this joint declaration,.it was obviously necessary to act quickly and start
negotiations as soon as possible (Albingi, 1990).
The Location Question within Iceland
During the previous 15 years, prior to starting negotiations with the ATLANTALgroup, the government had conducted studies to find the optimum location for power
intensive industries. In October 1980 the Minister of Industry (Hjorleifbr Guttomsson)
organized a committee (Stabarvalsnefnd um ibnrekstur, e. The industrial location
committee) to seek this optimum location and during the next few years the committee did
an extensive survey of locations in Iceland. The committee then recommended a few
locations that seemed to be the best choices although they emphasized that each of these
locations needed to be investigated fbrther (Stabarvalsnefnd um ibmekstur, 1983). The
committee also looked specifically for location choices for an aluminum smelter. The
result of the first report was that five sites in two regions were identified as the most
promising and should be investigated fbrther (StaBarvalsnefhd um ibnrekstur, 1982).
These five sites were; Helguvik by Keflavik; Vogastapi by Njarbvik; Keilisnes on
Reykjanes; and, Geldinganes by Reykjavik, all in the Reykjanes region (Figure 5.1 and
5.6); and, Dysnes not far from Akureyri, in Eyjafjorbur region (Figure 5.1 and 5.4)
(StaBarvalsnefhd um ibnrekstur, 1986). It might be noted that during the negotiations
between the Icelandic government and the ATLANTAL-group two other locations were
investigated, Grundartangi just North of Reykjanes region (Figure 5.1) and sites in the
ReyBarfjorbur region on the East coast (Figure 5.1 and 5.2). These two sites are examined
later in this chapter.
In a final report (StaBarvalsnehd um ihekstur, 1986), the committee did a
hrther investigation on the five locations it had recommended. In that report the
committee made a cost estimate for each site which included; the cost of the site,
construction on or by the sites, providing water to the site, road and harbour costs, wet
scrubbing of sulfbr dioxides (environmental pollution control equipment), construction of
power lines, and everything else except the construction of the smelter itself (Table 5.3).
Best possible pollution control equipment for aluminum smelters is very expensive.
Wet scrubbing of sulfbr dioxide is a part of such equipment and the cost of such
equipment is estimated at 630 million Icelandic kr6nur at all five locations. However, the
report argued that Keilisnes has the special advantage of being far from populated areas, it
is an open space location and winds blow towards the ocean and there is almost no threat
of dangerous pollution in the ocean from an aluminum smelter. Consequently, the report
suggested that an aluminum smelter at Keilisnes would probably not require a wet
scrubbing system and would therefore not have to pay the cost of wet scrubbing of
sulphur dioxide. This assumption established Keilisnes as the cheapest location (Table 5.3)
(StaBarvalsnehd um idnrekstur, 1986).
The government emphasized that the location should affect regional development
and help in creating a better economic balance within the country. The location that fitted
best into the government's regional development policies was the Dysnes location in the
EyjafjorBur region because it would create much needed jobs there and prevent hrther
migration of people from the region to the Greater Reykjavik area. As a result the
government tried to affect the location choice of the ATLANTAL-group. It was even
ready to pay for some of the difference in construction cost between different locations
(16nabarraBneytiiS 1990), especially if the ATLANTAL group agreed to build the new
smelter in the EyjafjorBur region (MorgunblaBiB, 199Oa). However, as the Eyjafjoraur
area is a good agricultural region state of the art pollution control would be required
which made Dysnes a more expensive location in comparison to Keilisnes. The EyjafjorBur
region has hrther disadvantages compared to the Reykjanes region. More than half of
Iceland's population lives in Reykjavik and the Reykjanes region and by locating the
smelter there amenities are more accessible. Another issues that also affects location
choice is providing the smelter with labour.
TABLE 5.3
COST ESTIMATES FOR FACILITIES IN RELATION TO CONSTRUCTION OF AN
ALUMINUM SMELTER IN FIVE LOCATIONS IN ICELAND
(Not Including Construction of the Smelter itself)
Location
Region:
Site:
000,000 Icelandic krbnur*
Reykjanes (map 5.4): Helguvik
1,619
Vogastapi
1,914
Keilisnes
860
Geldinganes
1,435
EyjafjorBur (map 5.3):Dysnes
1,560
*Prices January 1, 1986.
Source: Adapted from Staaarvalsnefnd um ianrekstur (1986).
One report estimated that the available labour force for the proposed smelter are
workers that live within 40-50 km radius from a site and the population in that area should
be no less than 5,000-6,000 people. Because of this the actual site should be in, at least,
some proximity to the largest population center in each region (ByggBastohun 1990b).
Table 5.4 shows that 645 workers are needed for operation of the smelter. According to
this report, smaller population centers than 5,000-6,000 will not be able to guarantee the
smelter with that many workers. The distance is the estimate of how far a worker is willing
to go to seek employment and also how good the transportation system is and possible
closures of roads during winter storms (Elyggbastofnun, 1990a; 1990b; IBnaBarrabneytib,
The debate about the location of the proposed aluminum smelter within Iceland
reached its peak during the first eight months of 1990. Morgunblabib (1989) describes the
battle between Municipalitiedregions to attract the new smelter, as an auction. According
to MorgunblaZIiB (1989) the smelter will locate in the Municipalitylregion that is the
highest bidder and is ready to sacrifice the most, such as taxes, harbour fees, and other
facilities. This is exactly what many had argued earlier that Icelanders would have to
avoid, that is domestic disputes over the location within Iceland. According to
Morgunblabib (1988; 1989) such disputes make the country a less attractive location in
the eyes of MNCs. However, it became evident that the parties would have to make a
decision where the smelter should be located.
TABLE 5.4
TOTAL LABOUR FORCE (ESTIMATES) NEEDED FOR CONSTRUCTIONS AND
OPERATION OF AN 200,000 TON ALUMINUM SMELTER AND NEW POWER
1990 1991 1992 1993 1994 1995 1996
Constructions of the
aluminum smelter
50
550 780 950
of that foreign
10
110 160 190
workers
Constructions of
278 635 810 718
power plants
Operation of smelter
175
Total labour needed
338 1295 1750 2033
Source: Adapted from Byggbastofnun (1990b).
70
10
447
410
937
645
645
645
645
In June 1990 the two parties confirmed that three regions should be investigated
hrther, the ReyBarfjoraur region which contained three possible sites, the EyjafjorBur
region which offered the Dysnes site, and Reykjanes region which contained the site of
Keilisnes (see Figure 5.1, 5.2, 5.4 and 5.6) (IhaBarraBneytia, 1990). The other three sites
in Reykjanes region had been dropped because they were more expensive than Keilisnes
(Table 5.3). Interestingly, ReyBarfjorBur region on the East coast (see Figure 5.1 and 5.2),
had not been mentioned before but the fjord had a history of being a location option for
power intensive industry. In 1982, for example, the Ministry of Industry published a
feasibility report for a silicon metal factory in ReyBarfjorBur. A firm was established and
the government negotiated with RTZ Metals to finance the project. However, due to
external changes, like higher supply cost, increase in construction costs and the world
market price of silicon metal during the latter half of 1986 and beginning of 1987, the
project never became economically possible. Some observers argue that if this silicon
metal factory had been built in 1987 it would have been a economically justifiable project,
that would have showed profits @oasson, 1994). However, because the Reyaarfjoraur
region had already been considered as a possible location for power intensive industry
much of the research work on location for an aluminum smelter had been done.
It might also be noted that another location possibility was considered by the
ATLANTAL-group, notably Grundartangi (Figure 5.1). The idea to build power intensive
industries at Grundartangi is not new because in 1977 a Ferro silicon smelter was built
there (see Chapter 1). However, the group, in a confidential letter to the government,
stated that Grundartangi was too close to the Greater Reykjavik area (75 km). This
argument, of course, is very strange since the location actually chosen is closer to the
Greater Reykjavik area than Grundartangi.
Ultimately, it were three regions that were given the greatest consideration and
these three possible locations will now be examined separately in the following order,
Reybarfjorbur region, Eyjafjorbur region, and Reykjanes region.
Reybarfjorbur Region
It is hard to explain why one of the 'final' three regions examined for the new
aluminum smelter was the Reybarfjorbur region in view of the fact that the committee that
recommended locations for power intensive industries and an aluminum smelter
(Stabarvalsnefnd um ibnrekstur, 1982; 1986) had not included the Reybarfjorbur region as
a possible location for an aluminum smelter. The main reason cited was that the
communities in the fjord are too small to provide an aluminum smelter with labour. It
should be noted that the committee (StaBarvalsnefnd um ibnrekstur) recommended the
region is a good location for medium size industry that only needed 100-300 workers.
However, after the ReyBarfjorbur region became an option as a location for the new
smelter three possible sites around the fjord were examined. According to ReybarfjorBur
district (1992) Eyri was considered as the best option (see Figure 5.2). The site within the
region was not a big issue; rather development and creation of new jobs in the region were
the main issues.
0lafsson (1993) argues that Reybarfjorbur region is a good location for power
intensive industry mainly because the construction of a harbour would be relatively cheap
compared to other possibilities in Iceland, the distance from Iceland to Europe by ship is
shorter from the East coast, and the next major power plant will most likely be
constructed on the East coast. He points out that few years ago the government had
decided to build a silicon metal production plant in the region but that the project had been
abandoned in 1987 and shortly after that the idea to build an aluminum smelter in
Reybarfjdrbur region surfaced. 0lafsson (1993) also argues that it was never the intention
of the government to build either of these factories in Reyaarfjoraur region and the option
was only kept open for political reasons since it fitted well into regional development
policies.
REYDARFJORDUR REGION
40 k n ~
to Egilsstaair
745 krn to Reykjavfk
Atlantic
ocean
b
0
5
10
20
I
30 km
fi
Village
Possible
Main roads
Figure 5.2. ReyaarfjoriSur Region and Possible Sites for Power Intensive Industry.
source. ~ d a ~ t efrom
d ~e$arfjiiraur district (1992); Staaanralsnefnd um ianrekstur
(1986).
Many have argued that the region has suffered because the government has been
implying that the East coast, in particular the Reyaarfjorbur region, will soon get some
kind of power intensive industry and therefore the region has not gotten as much financial
assistance for regional development as other regions. People in the region have been very
disappointed how the government has given the region false hopes, for more than 10 years
(~lafsson,1993; MorgunblaK3, 1990b).
In summary, four reasons have been offered to explain why the smelter was not
located in the Reyaarfjorbur region:
119
1) Some observers argue that ReyiSarfjoriSur region was only kept open because it fitted
well into the governmental regional development policies. These same observers argue
that the government never intended to build the smelter any where else than close to the
Greater Reykjavik area. By keeping the option open disputes within the country were
avoided. Evidence that supports this view is that the government did not spend as much
money or time to do research in the region as it did on sites close to the Greater Reykjavik
area (blafsson, 1993; MorgunblailiiS, l99Ob).
2) The only site that did not require wet scrubbing of sulhr dioxide was Keilisnes, which
made it impossible for other sites to be competitive, with regards to construction cost
(StaBarvalsnefnd um ibnrekstur, 1986). One source argued that a person in the Icelandic
negotiation committee mentioned (without authorization) that the government would not
require wet scrubbing if the group would locate the smelter at Keilisnes even though the
government's original intention had been to require state of the art pollution control
equipment wherever the smelter would locate.
3) It was argued that BuBareyri and the communities in the region would not be able to
provide the necessary labour for the project (see Figure 5.3). However, some observers
have argued that if the transportation system were improved and tunnels constructed to
connect fjords, people from more communities could be accounted for and there would be
no labour shortage for the project (MorgunblaBiB, 1990b; olafsson, 1990; ReyBarfjorBur
district, 1992).
4) ReyiSarfjorilur is a long fjord and is surrounded by mountains. Pollution is considered as
a major threat in the area because it is not a very windy location and pollution would not
be blown from the fjord toward the sea. Yet, 0lafsson (1993) and in ReyBarfjorBur district
(1992) it is stated that sufficient research has not been made to estimate the effect of
pollution in the region and 0lafsson (1993) argues that winds would clean the fjord of
pollution. According to 0lafsson (1993) the government has not been willing to provide
capital to do the necessary measurements, and pollution is a good reason (for the parties)
to eliminate Rey6arfjorllur region as a possible location (~lafsson,1993).
47-km to Eyri
Buhreyri
Population: 7 19
17 km to Eyn
Ftkknibsfj6r6ur
Population: 834
36 krn toEyri
Figure 5.3. Population Centers in the ReyBarfjorBur Region and Possible Labour Pool for
an Aluminum Smelter Located at Eyri.
Source: Adapted fiom Byggaastofnun (1990a), pp. 13.
No direct discussions or negotiations took place between participants from the
Reydarfjor6ur region and the ATLANTAL group (~lafsson,1993).
Eyjafjoraur Region
The communities in EyjafjorBurregion put a lot of effort and work in attracting the
new smelter. The Industrial Development Corporation of EyjafjorBur did an extensive
study of the area, which included physical, human, and economic perspectives. The
Eyjafjoraur region hlfilled all requirements that the ATLANTAL-group had listed, for
example, in terms of providing labour (see Figure 5.9, harbour, suitable site and other
services (Industrial Development Corporation of EyjafjorBur, 1990). As in the
ReyBarfjordur region the main emphasis was put on attracting the smelter to the region
not to specific sites. In Staaarvalsnefhd um iBnrekstur (1986) Dysnes was considered as
the best site and during negotiations it was assumed that a location in the Eyjafjorbur
region meant that the site would be Dysnes.
The Eyjafjorbur region was the optimum location with regards to the
government's regional development policies (Morgunblabib, 1990b). In addition, the
Minister of Industry (Jon Sigurbsson) wanted the new smelter to be located in the
Eyjafjorbur region (see Figure 5.4). According to Morgunblabib (1989; 1990) the Minister
was considering running for office in the constituency which Eyjafjorbur region is a part.
Providing an aluminum smelter in the constituency would strengthen his position to be reelected (Morgunblabib, 1989; 1!Bob).
In summary, three reasons have been offered to explain why the smelter was not
located in the Eyjafjorbur region:
1) The same political reason mentioned for the Reybarfjorbur region also apply in the
Eyjafjiirbur region (~lafsson, 1993; Morgunblabib, 1990b). However, there are
indications that the government wanted to build the smelter on the North coast, in
particular Eyjafjorbur region, as it fitted into regional development policies. There are,
however, arguments that the ATLANTAL-group opposed to such a strategy for reasons
mentioned below and because of disputes within the region concerning this new project.
Thus farmers in the region opposed the project and argued that an aluminum smelter
would destroy their farmland. The ATLANTAL-group had concerns about these protests
(Morgunblabib, 199Ob).
2) The same environmental reasons mentioned for Reybarfjorbur region, that is wet
scrubbing of sulhr dioxide was not required at Keilisnes which made that site the cheapest
location (Stabarvalsnefhd um ibnrekstur, 1986).
E Y J A ~ R UR
D REGION
Figure 5.4. Eyjafjorbur Region and Possible Sites for Power Intensive Industry.
It should be noted that Gaseyri was considered as a location choice in the negotiation with
Alusuisse 1961- 1966.
Source. Adapted from Industrial Development Corporation of Eyjafjorbur (1990);
Stabarvalsnefnd um ibnrekstur (1986).
3) It was argued by both the Icelandic government and the ATLANTAL-group that
harbours in the fjord could close during winter time, due to drift-ice. However, since 1940
drift-ice has blocked Eyjafjorbur (the fjord) only twice, in 1965 and 1968, and only for a
short period of time (Industrial Development Corporation of Eyjafjorbur, 1990). Because
this issue was used (among others) to eliminate Dysnes as an alternative for the new
smelter the Industrial Development Corporation of EyjafjorBur conducted a new research
to examine if drift-ice eliminated the Eyjafjoraur region as an alternative for power
intensive industry. The conclusion was that drift-ice is a concern, but that the Eyjafjoraur
(the fjord) harbours have very rarely been closed to ships fiom both East and West at the
same time. Drift-ice should not be concerned as a major threat, and should not affect
decisions concerning the location choice of an aluminum smelter (Kristinsson, 1993).
No direct discussions or negotiations took place between participants fiom the
Eyjafjorbur region and the ATLANTAL-group (Magnusson, 1993).
Grenivik
Population: 422
69 km to Dysnes
Population: l , l 4 1
41 km to Dysnes
I
0
I
I
Population: 1,738
'23-km to Dysnes
Akureyri area
Population: 15,000
23 km to Dysnes
Figure 5.5. Population Centers in the Eyjafjorbur Region and Possible Labour Pool for an
Aluminum Smelter Located at Dysnes.
Source: Adapted from Byggbastofnun (1990a), pp. 9.
Reykjanes Region
After other sites in Reykjanes region had been eliminated because of cost, Keilisnes
became the optimum site in the region. Keilisnes, or in particular the Reykjanes region (see
Figure 5.6), was the location that the government was least interested in locating the new
smelter because it would not be in harmony with existing regional development policies.
However, Keilisnes was still the cheapest option for both parties (see Table 5.3) and in
124
October 1990 the ATLANTAL-group declared that it had chosen Keilisnes as a location
to build the new smelter. One of the main reason was that the other two locations had too
many unforeseen obstacles in the way (Ibnaijarrabneyti6, 1990). It would be difficult to
provide labour in Reybarljorbur while pollution would threaten other activities in the fjord.
Dysnes was eliminated because it was a more expensive location, because of the possibility
of drift-ice closing the harbour, and the ATLANTAL-group did not feel as welcome there
(Nordal, 1994) because of protests by farmers.
Reykjanes region
I
I
0 Village <5,000
Town >5,000
Atlantic ocean
&I Possibles
&s
A
Aluminum plant
Main roads
Figure 5.6. Reykjanes Region and Possible Sites for Power Intensive Industry.
Source. Adapted from Staijarvalsnefnd um iijnrekstur (1986).
Numerous reasons have been mentioned why the smelter will be located in the
Reykjanes region such as providing labour, costs, and pollution control equipment. There
are also indications that Reykjanes region had been a corporate preference because of its
125
closeness to all kinds of amenities, it is not far from Keflavik International Airport, and
access to necessary services is best provided by locating in Reykjanes region as it is in
close proximity to Iceland's largest population centers (Figure 5.7). In addition, a poll,
conducted by the Institute of Social Sciences at the University of Iceland in 1990, showed
that 5 1.1% of the nation was in favour of locating the new smelter at Keilisnes. The pole
also showed that 67.7% were in favour of building a new aluminum smelter in Iceland
(Felagsvisindastofhun, 1990). However, the decision was also criticized especially from a
regional development perspective. Many argued that by locating the smelter close to the
Greater Reykjavik area it would lead to mass movement of people (looking for work) to
the South-West where more than onehalf of the population already lives (Figure 5.1 and
5.7). Such a location would increase regional differences within the country. Moreover,
critics argued that the reason why Keilisnes was an economically cheaper location was not
to require that the same pollution control equipment would be installed there. If pollution
control equipment were to be installed, it would no longer be a cheaper option and the
possibility of another location had been an alternative (Morgunbla6i6, 1990b). According
to Nordal (1994) the cost of pollution control equipment was not the only issue but
Keilisnes is in a much lesser risk of environmental damages than other possible locations,
winds blow toward the ocean and the site is in the Reykjanes lava were there is little
vegetation. He argued that the ATLANTAL-group would probably be required to
establish the same pollution control equipment wherever the smelter would be built.
The location decision was a big step towards the reality that a new aluminum
smelter would be built in Iceland. In May 1990 Jon Sigurasson (Minister of Industry)
argued that the location decision was the most important step and a clear sign that the
ATLANTAL-group had full intention of building a new aluminum smelter in Iceland
(Sigurasson, 1990).
Sandgerbi
Population: 1,254
Garbur
Population: 1,071
31 km to Keilisnes
Suburnes
Population: 9,834
24 km to Keilisnes
n
Greater Reykjavik area
Grindavik
Population: 2,143
29 km to Keilisnes
Population: 143,902
24 km to Keilisnes
Figure 5.3. Population Centers in the Reykjanes Region and Possible Labour Pool for an
Aluminum Smelter Located at Keilisnes.
Source: Adapted from ByggiSastofnun (1990b), pp. 3.
Power: Price and Supply
During the summer of 1984 the Icelandic government started building a new
Hydro-electric plant at Blanda, at least partly to prepare to provide new power intensive
industries with energy. A little later the government put together a long term plan which
indicated the order in which power plants would be built. Two plans were made, plan 210
includes a new 210,000 ton aluminum smelter and plan 0 which does not include an
aluminum smelter (Albingi, 1990). Construction of the Blanda power plant was a part of
both plans and in 1991 construction of Blanda power plant was completed
(IBnaiSarraheytia, 1991a). Though the Blanda power plant is not big enough to provide a
new aluminum smelter with energy it is the first step. Moreover, when negotiations with
the ATLANTAL-group began, the price rather than the supply, of electricity was not a
major concern.
In the negotiations the government emphasized that net income from electricity
sales would finance the construction and operating costs of power plants, that the
electricity price would be in direct connection to aluminum price, and that the smelter
would get a rebate on the electricity price during the first years of operation. The
ATLANTAL-group mostly agreed to these conditions and in 1990 the two parties reached
an understanding in principle on the following contract issues:
(a) The power price will be calculated as a certain percentage of aluminum price with an
initial period of discounts and a floor and cap for the years 1994 through 1996.
(b) The power supply will be for approximately 3000 Gwh per year, with 90% delivered
as firm power.
(c) The obligations of the Company will include an obligation to take or pay for 90% of
the firm power during any 10 consecutive years.
(d) The contract will contain a fairness clause.
(e) Certain of the terms and conditions for power delivery with delivery starting in 1994.
(f) The power contract period will be for 25 years with the Company having the option to
extend the contract period by two additional five year periods.
The power contract, when finalized, is subject to board approvals.
(Icelandic government and the ATLANTAL group, 1990).
One of the main reasons why the Icelandic negotiators emphasized that the price of
power would be calculated as a certain percentage of aluminum price was to guarantee
that one party is not making too much profit nor losing too much (Nordal, 1994). They
also pointed out that aluminum prices are forecasted to rise and that the price of power
would rise at the same time. This argument was criticized and according to Gestsson
(1991) the average price of aluminum from 1960-69 was US$ 1,822~per ton, during the
1970s it was US$ 1,8181, in the 1980s it was US$ 1,648' and during 1990 the price was
US$ 200 lower than the decade before. There is nothing that indicates that this trend will
change (Gestsson, 1991).
Critics also used a different approach to criticize the power agreement. The
National Power Company is Iceland's richest company. During 1990 the company's profit
was 3% or 714 million Icelandic kronur but ISAL's profit at the same time was 44% or
1,755 million Icelandic kronur. Using these figures for comparison it is obvious that ISAL
' Numbers have been adjusted for inflation.
4
is getting the power too cheap and has been getting it too cheap since the smelter was
built (Juliusson, 1991). Now the government is negotiating another agreement to build
another aluminum smelter, and again making the same mistakes, selling the energy too
cheap (Juliusson, 1991; Gestsson, 1991). The government does not agree with this view
and Nordal(1994) argues that Iceland has gotten adequate revenues from electricity sales
to ISAL.
Taxation
Two ideas were put forward concerning taxation of the smelter. The ATLANTALgroup emphasized the idea of paying a fixed tax on each produced ton of aluminum. The
government, on the other hand, argued that the smelter would pay taxes just as other firms
pay taxes according to Icelandic taxation laws, but it could have a few exemptions,
because of its size and specialization (Albingi, 1990). The Icelandic taxation system has
been going through rapid changes during the last few years which are supposed to simpliQ
the system and make it more comparable to other Western countries. Thus the Icelandic
negotiation committee saw no reason why Icelandic laws should not be used when taxing
the proposed smelter (Sigurbsson, 1990; 1994). The real debate is the actual level of
taxes.
In this regard, whatever the final decision, the ATLANTAL-group wants all taxes
to be stated in the final agreement and that the government will not be able to add new
taxes. In particular, the ATLANTAL-group has required a so-called 'non discrimination
clause' in the final agreement (Albingi, 1990).
In October 1990 the two parties reached an understanding that in principle the
ATLANTAL companies will generally be taxed pursuant to Icelandic laws, but other
principles of taxation will be applicable (for hrther details, see appendix 2, article 2.2)
(Icelandic government and the Atlantic group, 1990).
I
Import Duties
Both parties have agreed that the smelter will be a tolling smelter, which means
that the firm will not own the alumina nor the aluminum it produces and does therefore
not have to pay import duties. The proposed smelter will collect a certain production fee
per produced ton of primary aluminum. (Albingi, 1990).
Legal Issues
Both parties have agreed that the smelter will operate pursuant to Icelandic laws.
The government has emphasized that all conflicts should be resolved by Icelandic courts,
but the ATLANTAL-group has argued that major conflicts should be solved by an
international court of arbitration, which would use Icelandic laws. The group points out
that Iceland and all three home countries of the ATLANTAL companies are participants
of the ICSID (International Center for Settlement of Investment Disputes) in Washington,
which solves international financial conflicts and could therefore solve disputes that could
rise between the proposed smelter and the government (Albingi, 1990).
The Icelandic government emphasized that it has been changing laws and
regulations that affect MNCs. These new regulations are internationally comparable and
the Icelandic justice system is therefore well prepared to solve international disputes
(SigurBsson, 1994). During the negotiations the ATLANTAL-group agreed to this, so
Icelandic laws will govern the agreements and disputes will generally be settled pursuant
to Icelandic law by Icelandic courts or alternatively by arbitration pursuant to Icelandic
law (Icelandic Government and the ATLANTAL group, 1990).
Duration of the Agreement
The government wanted the duration of the agreement to be no longer than 25
years, and that there would be no obligations after that. The ATLANTAL-group wants a
*
longer agreement. A final resolution had not been reached regarding the duration of the
agreement when formal negotiations ended in 1991 but according to ideas regarding the
power agreement, it is likely that the contract period would be 25 years and the
ATLANTAL-group will have the option to extend the contract period by two additional
five year periods.
The Status of the Negotiations, 1991- 1994
In November 1990 the two parties decided that both the Master Agreement and
the Power Agreement should be signed no later than February 1991 (IbnaiSarraiSneytib,
199la). However, between November 1990 and February 1991 there was a delay in the
negotiations. First the ATLANTAL-group delayed the negotiations to finish agreements
within their own companies and then the Gulf War started. The two parties met again in
February 1991 for an overview of the negotiations and the parties decided to finish all
agreements before spring 1991 (Ibnabarrhbneytib, 1991a). At that meeting it became
evident that the Gulf War would affect the financing of the project, in September 1990
total investment for the project was estimated to be US$ 1 billion, and that it would be
necessary to delay the negotiations for another 6-10 months. Still the group had no
intention of dropping the project but it was clear that start-up would never be before early
1995.
In August 1991 the two parties reached an agreement about all major issues
concerning the Master Agreement and the ATLANTAL companies were optimistic that
they could finish agreements with banks and other financial institutions, to provide capital
for the project, before March 1992 and would then be able to sign a Master Agreement
The two parties met again in November 1991 and at that meeting it became clear
that the project had to be postponed longer. The reason was that the ATLANTAL-group
could not raise the capital needed for the project. In August 1991 it was a general belief
that the price of aluminum had reached the lowest it could get. Economists forecasted that
the world economy would improve during the latter half of 1991. That did not happen and
between August and November aluminum price dropped hrther (see Figure 5.8).
1988
1989
1990
1991
1992
1993
1994
Year
Figure 5.8. Development of Aluminum Prices at the London Metal Exchange (three month
average price) 1988-1993.
Source: Adapted from Palsson (1993), pp. 4.
I
One explanation for this development is that Eastern European countries were selling their
inventory of aluminum, which they had kept in the case of warfare. Now the Cold War
was over and these countries needed foreign capital, especially the countries of former
Soviet Union. One way of getting capital was to sell aluminum supplies (see Figure 5.9)
(Idnal5arridneyti5, 1991b). At the same time these countries increased their production of
aluminum. As can be seen by comparing Figure 5.8 to 5.9, there is a clear connection
between the price of aluminum and exports from former Soviet Union countries. This
meant that many aluminum companies decided to cut production and even some closed.
No financial institutions were interested in providing capital to build a new aluminum
smelter in Iceland while these conditions were dominant (Idnadarribneytid, 1991b).
1988
1989
1990
1991
1992
1993
Year
Figure 5.9. Aluminum Exports from Former Soviet Union Countries to Western Countries
1989-1993.
Source: Adapted fiom Palsson (1993), pp. 4.
Participants argued that these circumstances were unusual and probably would not last
long. The ATLANTAL-group argued that the hture of the aluminum industry was bright
and that circumstances in Iceland for aluminum industry are one of the best. The group
emphasized their intention to build a aluminum smelter as soon as the world economy
would get more stable and the price of aluminum on the world market increases.
Discussions between the two parties have continued and as soon as circumstances change
the ATLANTAL project may well be given the go-ahead (Ibnabarrabneytib, 1991b;
Evans, 1993).
Delay in the ATLANTAL Proiect - Reflection on Timing
The negotiations with the ATLANTAL-group were very time consuming. They
began in 1987 and ended in 1991, though informal discussions are still ongoing. So why
has the smelter not been erected? Most issues that needed resolution in the negotiations
were complimentary to both actors but other reasons affected the negotiations and
prevented the signing of a Master Agreement.
During the late 1980s there was a change in government. The new government did
not have as much interest in erecting a new aluminum smelter as their predecessors. They
argued that there were better ways to utilize the energy resource than inviting powefil
MNCs to locate in Iceland, and the negotiations were delayed over a 10-14 month period.
Some argue that if this delay had not come into effect an aluminum smelter would have
been hlly built at Keilisnes in 1994. Another factor is that the Minister of Industry, Jon
Sigurbsson 1988-1993, has been criticized for taking the smelter on a 'carousel' ride
around the country. It should be noted that Jon Sigurbsson was one of the biggest
supporters of the new aluminum project. However, although he stayed on as a Minister of
Industry despite the change in government in the late 1980s he could not pursue the
I
project during that time. He was so convinced in the late 1980s that Alusuisse would
enlarge ISAL that he promised to locate the next smelter in a different region, other than
Reykjanes, and he gave every location a hint that the smelter could be located there. This
not only made the Icelandic public cofised but also the contracting party and this led to
protests from the people, including the protest by farmers in the EyjafjorBur region which
made the group feel unwelcome.
The nature of the business cycle is also important in explaining the delay. Krurnrne
(1981) identifies the importance of timing in the bargaining process. He mostly focuses on
the procrastination cost for each actor and how it can affect whether a business
relationship can be forged or not. Decision-making to erect a new aluminum smelter has
become subject to the business cycle (Nordal, 1994). Investment decisions are not taken
except during a short period of time during the upswing of the business cycle and/or
during fluctuations in the world market price of aluminum. Figure 5.10 shows a model of
the business cycle and when the bargaining process must take place and investments
decisions have to be taken. Optimum timing for both the negotiations and the final
decision is an important factor, to enable both actors to reach a complimentary agreement.
This could indicate that if the Icelandic government had pursued to reach an agreement as
soon as possible during the negotiations with the ATLANTAL-group, an agreement could
have been reached in 1988-1989 when aluminum prices were rising and there were signs
that the rise could continue in the near future (see Figure 3.2 and 5.8).
There are some indications that the global economy reached the bottom of these
fluctuations at the end of 1993. For example, the U.S. economy has been improving
during the first half of 1994. Another indicator, which is more important to the aluminum
industry, is that aluminum prices have risen roughly US$ 500 per ton during the first six
months of 1994. The reason is that at the end of 1993 all major producers of aluminum,
including Russia, reached an agreement to cut production to force up prices
(MorgunblaBiB, 1994a; 1994b). This could imply that negotiations with the ATLANTALgroup could resume within a few years. In this respect, although a preliminary agreement
with the group had been reached in 1991 it will be necessary to start negotiations again
because some parts of the agreement will need updating, for example cost estimates and
providing power to the proposed smelter.
The
10-15 years
Figure 5.10. A Model of the Business Cycle and the Optimum Timing of the Bargaining
Process and Decision-making.
Figure 5.11 shows how fbture developments can evolve between the Icelandic government
and the ATLANTAL-group, by applying the model shown in figure 5.10. It has been
argued above that at the end of 1993 the world economy and price of aluminum started to
rise and here it is forcasted that this trend will continue. There are no indications that the
demand for aluminum will decrease in the future, rather the opposite. Evans (1993) has
implied that, at least Alumax, has no intention of dropping the project, and the Icelandic
government is also eager to close the deal and begin construction.
,
Figure 5.11 assumes that the bargaining process will be shorter than it was before.
Iceland is better prepared today than it was 5 years ago to reach an agreement in a short
period of time for two main reasons; first, an agreement was reached in 1991 regarding
the most important issues and that agreement will (only) need updating; and second, the
government can supply a new aluminum smelter with energy at shorter notice because
there is a larger surplus of energy since the Blanda power plant is now in operation.
Bargaining took place
Business relation could
Operation begins 1999-2002
Bargaining process
10-15 years
Figure 5.11. The Bargaining Process between the ATLANTAL-Group and the Icelandic
Government 1987-1991, and the Possibility of Forging a Business Relationship in the
Future.
The model, of optimum timing (Figure 5.10) can also be applied to explain other
negotiations, such as the negotiations between the Icelandic government and Alusuisse
(1961-1966) outlined in chapter 4. Those negotiations were ongoing in the 'post-war era'
,
which was known for its stable economic growth. It was fortunate, however, that the
negotiations were not delayed and that the operation of ISAL began in 1969 because if the
start-up or the negotiations had been delayed for a few years, for one reason or another,
the turbulent economic times of the early 1970s (oil crisis) could have altered the
negotiation situation. The situation could have become conflicting and the two parties
would not have been able to forge a business relationship. These turbulent times affected
the power agreement and it rendered obsolete during the early 1970s, originally the price
of power was to remain unchanged for 15 years. This implies that the negotiations with
Alusuisse during the 1960s were ongoing at the optimum time for both parties, and that is
one of the reason why the parties reached a negotiable situation.
CHAPTER VI
CONCLUSION
The aim of this concluding chapter is to assess the research question set out in
chapter one, that is, 'To compare the different bargaining processes and to assess how the
spin-offs of the first bargaining process affected the second'. In addition, some comments
on the framework adopted in this thesis will be offered.
The bargain in^ Framework
In this thesis the bargaining framework introduced in Chapter 2 has been applied to
examine bargaining processes between the Icelandic government and aluminum MNCs.
The intention was to examine the negotiations and interpret industrial location as a result
of location conditions created by the bargaining processes.
The structure of bargaining emphasizes the bargaining power and ability of
participating actors. The concept of bargaining power is not easy to interpret and the
literature examining bargaining power overlaps and is contradictory. Nevertheless, this
thesis has demonstrated the validity of interpreting industrial location as a bargaining
process. Certainly, the power of the aluminum MNCs in the negotiations with the
Icelandic government can be recognized. The Icelandic government has changed laws, for
example taxation laws, to simpliQ the entry process for MNCs, aluminum MNCs do not
have to pay import duties, them are offered lower electricity price than other firms in
Iceland, and in the second case study the Icelandic government had to accept the
ATLANTAL-group's location choice. In spite of these considerations, Nordal (1994)
argues that Iceland had, and still has, probably a little better bargaining position when
negotiating with the ATLANTAL-group than when the government negotiated with
Alusuisse 30 years ago. He argues that valuable experience, learning, and spin-offs, fiom
the last three decades, have been gained. In addition, he argues that the development of
power production is also an important factor regarding the government's bargaining
situation. The Blanda power plant is now operating and it would take a shorter time to
provide a new aluminum smelter with energy now than few years ago.
As Chapter 3 outlines, the aluminum industry needs some specific location
conditions, such as cheap energy, so that operation can be economically justified. Iceland
is not the only country in the world that can offer aluminum smelters favourable location
conditions and since the country began focusing on attracting aluminum MNCs, during the
1960s, the country has faced fierce competition fiom other countries which offer similar
conditions, such as Norway and Canada.
The first bargaining process examined in this thesis (Chapter 4) is a little simpler
than the second one (Chapter 5). In the negotiations between Alusuisse and the Icelandic
government all issues were negotiable and a Master Agreement was signed. The second
case, that is the negotiations between the ATLANTAL-group and the Icelandic
government all issues were, also, negotiable. However, a final agreement could not be
signed. During the negotiations the two parties reached a preliminary agreement but due
to external reasons, namely turbulence in the global economy and fluctuations in aluminum
prices, it was impossible to sign a final agreement. In chapter 5 the importance of timing is
introduced. Contreras and Gregersen's (1975) framework does not consider time as a
major factor in the bargaining process but as has been shown by the model of optimum
timing (figure 5.10) it is an important factor and can even be the deciding factor whether
an investment takes place or not. Indeed, the bargaining process is often very time
consuming and economical changes in the world can happen with a short notice and alter
the negotiation situation.
In the framework of the bargaining process the importance of minimum
requirements is described. According to Contreras and Gregersen (1975) the outcome of
the bargaining process depends on these minimum requirements. This view is not entirely
the case in either negotiations examined in this thesis. Alusuisse did put forward minimum
requirements at the beginning of the negotiations with the Icelandic government in 1961
but as the negotiations evolved these requirements were changed. The same applies to the
second case were neither the Icelandic government nor the ATLANTAL-group appeared
to put forward any specific requirements. Contreras and Gregersen's framework can also
be criticized as it does not assume for other participants in the negotiations. In both case
studies in this thesis other participants play an important role, especially the World Bank in
the first case study. Financial institutions were not the only other participants, regional or
local governments and/or opposition parties, in the parliament, affect the outcome directly
and should be included in the framework of the bargaining process.
However, the bargaining framework does explain two important things; first, how
location conditions are created through the bargaining process and ultimately were
aluminum MNCs locate; and second, it determines the international competitiveness of a
country's aluminum industry. Through negotiations the Icelandic government has created
one of the most favourable location conditions for a new aluminum smelter in the world.
Alumax's president and CEO Born (1994) continues:
"...whenwe see that the increase in demand Cfor aluminum) has risen high enough, we
will resume with our plan to construct a new smelter at Keilisnes which is with out a
doubt ourfirst choice as a locationfor a new smelter." Porn, 1994).
The Case Studies Compared: Bar~aining,Spin-offs and Power
Evidently during the negotiation with Alusuisse 1961-1966 the prospects of MNCs
was first debated in Iceland. It became a fierce debate which focused on the impact that a
MNC would have on a recently developed economy and the impact it would have on the
future economic structure and even independence of a small island nation. This debate, the
experience of the negotiations with Alusuisse, and then later the operation of ISAL
aluminum smelter, obviously affected the more recent negotiations with the ATLANTALgroup.
The experience of the ISAL smelter has been good. Since operation began in 1969
the relationship between the smelter and all participating interest groups, such as labour,
government and the local government, has been good and most people seem to agree that
the agreement made in 1966 and the revisions that followed was a good contract for the
nation. Therefore it is not surprising that the government emphasized expansion of the
aluminum industry. The experience and the learning process from the first negotiations is a
valuable asset for the government when preparing for another bargaining process. It
should be noted that learning and experience is not only important for the government,
MNCs are also better prepared because they have also experiences fiom past projects
which they can use to strengthen their bargaining situation. It should be noted that not
everybody agrees that the Master Agreement with Alusuisse was a good deal and as long
as a government participates in negotiations with MNCs the critics of the government will
always argue that the government made a bad deal by arguing, for example, that electricity
price is too low, taxes are too low, and the government did not require 'state of the art'
pollution control equipment.
Nordal (1994) argues that though learning has been a very important factor
concerning future investments in the country it has not increased Iceland's bargaining
I
power, except a little. He points out that a country's bargaining power results from
competition with other countries. During the last 25 years Iceland's competition has
mostly been coming fiom Canada and Norway. What these countries offer MNCs, price of
power, taxation, environmental regulation, costs, labour, and other important issues, is
what Iceland can get. These countries, and specially Canada, Canada has been known for
its foreign investment policies, set the standards which others have to follow. The
competition is as harsh today as it was during the last three decades, though it is not
coming fiom Canada any more as other countries for example Venezuela and Russia (or
Siberia) have become important. The country's bargaining power will still be based in
offering cheap and environmentally accepted energy and a low risk location in the form of
stable economic and political environment. It can therefore be argued that Iceland is in a
better bargaining situation now than when negotiations with Alusuisse began. This better
bargaining position is a result of the learning process and the experience from the ISAL
project. However, as Kobrin (1987) (Figure 2.5) explains, relative bargaining power can
shift between the HC and MNC over time. There is a possibility that the ATLANTAL
companies have gained bargaining power during the delay of the ATLANTAL project
because during the period 1991-1994 aluminum MNCs have closed smelters andfor
reduced production, so the possibility exists that some regions could have considerable
amount of surplus energy which they are prepared to sell for a low price.
Future Research Questions
This thesis is an in-depth research of the bargaining process between the
government and aluminum MNCs. However, in a work such as this it is impossible to
address every relevant issue and, as such, certain issues remain undressed.
First, there is the question of the actual economical impact of foreign direct
investment in Iceland. Foreign investment entry barriers to protect resources are still in an
effect, especially in protecting the fishing industry fiom foreign investment. Recent
changes in Europe may make it impossible to keep these barriers and as Europe grows
into one unit, the EU, it will be difficult for a small island to stand outside. If Iceland joins
the EU the country will lose, in part, its management power over the fishing industry. It
will be difficult to measure the impact, not only economic but also social and political, if
the country joins the EU. This, however, will probably be unclear until after negotiations
and bargaining with the EU.
Second, there is the issue of bargaining power. According to Nordal (1994) the
bargaining power, of a nation, is a result of competition between countries but as argued
in chapter 2, bargaining power is a controversial issue that is very difficult to measure.
However, is there anything that the government can do to strengthen its bargaining power
and increase its bargaining ability?
Finally, there is the question of the hture of power intensive industries in the
country. The most recent phenomenon concerning hrther utilization of the energy
resource is exporting energy through a cable directly to Europe. Today, there is ongoing
research on whether it is possible, technologically and economically, to do this. If this is
possible how would that affect Iceland's economy? This has been criticized because by
doing this the country would be exporting jobs abroad. Nordal (1994) argues that the
nation would not lose its attractiveness as a location for power intensive industry, because
energy prices in Europe must be at least 10-15 mills higher per Kwh than in Iceland
before this is possible. This means that MNCs will still want to locate in Iceland because
the country will still hold its advantages, that is being able to provide cheap energy and a
low risk location and at the same time create jobs in Iceland. h o t h e r issue that has been
criticized regarding this development is that it would be very difficult for such a small
economy to provide capital for construction of many power plants simultaneously so that
the project can be economicallyjustified. Project of this magnitude would also have a huge
impact on the environment and it is likely that environmental groups and others would
oppose to such development.
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Appendix 1
Memorandum between the Icelandic Government, Alusuisse
and the World Bank
Memorandum of meetings between representatives of the Icelandic Government,
Alusuisse and the World Bank, held in Ziirich from December 15 to 17, 1964. The
following points were discussed, it being understood that the positions taken by the
representatives of Alusuisse and the Icelandic Government are subject to the approval of
the Board of Alusuisse and of the Icelandic Authorities.
Part 1
General understandings
1. Introduction
A single potline aluminum smelter with an annual output capacity of approximately 30.000
ton of virgin metal will be constructed at Straumsvik in the Hafnarfjordur area and put into
operation not later than the permanent delivery date for power. A sufficient supply of
power will be provided for operation of the smelter, that is, 55 MW of continuous power,
from the prospective Burfell power plant and interconnected power plants.
2. Price of Dower
The price of electricity to the smelter to be a basic amount of 0.25 US cents per Kwh for
the first fifteen full years of operation, with no change for the ensuing ten years of
operation other than for an adjustment of variable costs for electricity in relation to
changes incurred in cost of labour and operating supplies.
It is envisaged that during the first ten years the price of power will be 0.30 US cents per
Kwh, with a corresponding reduction in applicable taxes (as to which see paragraph 4
below).
3. Guaranteed Minimum Annual Amount
The power sales to the smelter company will be under a "take or pay" contract, in which
the smelter company will be obligated to pay for a minimum of 450 Gwh per annum
irrespective of use, subject only to force majeure as may be defined and the effects thereof
4. Taxes
a) During the first 25 full years of operation taxes due by the smelter company shall be as
follows:
(1) For the first fifteen full years of operation a fixed amount of US$20 per metric
ton of metal shipped. This fixed amount to increase by US$7 per metric ton for
every one cent per lb by which the world market price shall increase beyond 27
centsflb. Fractions pro rata.
(2) After fifteen full years of operation the tax per metric ton of metal shipped shall
increase to US$35 subject to the effects of a change in world market price as per subparagraph (1).
It is specificallt envisaged that as long as the price of power is 0.30 US cents per Kwh
(see paragraph 2 above), the tax per ton of metal will be $7.50 less.
b) The problem of exempting the proposed aluminum smelter from any and all customs
duties, taxes, fees and other charges levied on capital goods and raw materials, supplies
and products entering Iceland or leaving Iceland, is thought to be best achieved by
establishing, through Act of Parliament, an industrial freeport extending over the whole
plant area.
c) Apart fiom the tax to be levied on the smelter operation according to sub-paragraph a)
above, the smelting company shall not be liable to pay any taxes, State, municipal or other,
which are or may be imposed in Iceland except such levies as are
in the nature of social security charges or fringe benefits to labour, such as the
contribution to the State Unemployment Fund, the similar contribution to the State,
Housing Fund and accident insurance premiums as are paid by other Icelandic
employers, or
(1)
(2)
are in the nature of services rendered to the smelter company.
Alusuisse shall at all times be exempt fiom taxation in Iceland in connection with the
smelter company, and its possible winding up, and it shall at no times be deemed to have a
permanent establishment in Iceland.
d) Registration fees and other expenditures connected with the incorporation of the
smelter company shall be kept at a reasonable level. Alusuisse would not expect such
expenditures to exceed 2.2%0 (two and two tenths permille of the paid-up share capital.
5. Guarantees by Alusuisse
Alusuisse will guarantee
a) the annual minimum payment referred to in paragraph 3
b) other payment obligations of the smelter company to the Icelandic Government and
the Power Company
c) construction of smelter by escrow deposit or other satisfactory technique.
6. Miscellaneous
The cost of the smelter site shall be reasonable whether it be a purchase price or a
yearly rental.
The Government shall grant, free of charge, a concession for sinking water wells at a
suitable place on or near the plant site.
The Government shall charge harbour fees directly related to the financial and
operating charges involved taking into account harbour movements for third parties.
The Government shall grant normal credit facilities to employees of the smelter
company (other than Alusuisse personnel) desiring to construct or purchase a house.
If it proves necessary, at a later stage, to implement a larger scale housing program
the smelter company will not be required to provide adequate infrastructure such as
roads, water mains, sewers, electricity, and so forth.
In order to avoid incurrence of problems arising from possible foreign exchange
control regulations, it is assumed that payments for metal received are limited to
what is required to meet operating expenses in Iceland including Icelandic tax
liabilities and that thereforee, they do not include capital charges and profits. The
smelter company shall at all times have at its disposal in Iceland reasonable liquid
f k d s to meet its current obligations.
7. Scope of Contracts
It is the intention that the scope of the contract be limited to the proper activities of the
smelter company. In this connection and in line with the practice generally followed in
other Alusuisse reduction plants the production of the smelter shall include alloyed or
unalloyed remelt ingots, rolling and extrusion ingots, wire bars, continuous casting of
strip, rod and slugs and in general all products starting from liquid metal out of the
smelter's cast house. The smelter activities will not include fabricated products such as hot
and cold rolled sheet, extrusions and forgings. The Icelandic representatives will seek
technical advice on this matter and inform Alusuisse of their position.
Part I1
Maior Issues To Be Resolved
Both parties, the representatives of Iceland and of Alusuisse, agree on necessity of having
clear provisions regarding the expansion of the smelter and the duration of the contractual
arrangements.
1. Duration of Contracts
Alusuisse expects the agreement between the parties to have a duration of 50 years subject
to extension each time the parties agree on installing additional plant capacity.
In respect of the second period of 25 years of operation of the initial 30.000 ton stage
Alusuisse expects to be granted an option for an extension of the power contract and of
the tax convention on terms and conditions which will enable the smelter company to
continue operations on an economic basis.
2. Expansion of Smelter
Alusuisse expects being able to start operation of a second 30.000 ton potline
approximately three years after completion of the first 30.000 ton potline. Alusuisse is
prepared to noti@ the Icelandic Government of its final decision regarding a firm
commitment for an additional block of 55 MW no later than 24 months after start-up of
the first 30.000 ton potline.
Alusuisse desires the Icelandic Government to grant an option to contract for such
additional block of 55 MW on terms and conditions in every respect identical to those
applicable for the initial 30.000 ton potline.
Beyond the 60.000 ton stage Alusuisse is prepared to consider carefblly the erection of a
second aluminum reduction plant in Iceland to be located in the general area of Akureyri.
The Icelandic representatives propose instead of such option, to give Alusuisse a letter of
intent regarding the expansion and its terms and conditions.
(Alusuisse, 1964c, pp. 1-6).
Appendix 2
Preliminary agreement between the Icelandic government
and the ATLANTALP~ouD
During the period from June to October 1990 the two groups met frequently to negotiate
important issues, for example taxation, price of power, etc. These negotiations lead to a
memorandum of agreement between the Icelandic government and the ATLANTALgroup signed on October 4, 1990, and is as follows:
-Whereas the Parties signed a Declaration of Intent to Conclude Negotiations on the
ATLANTAL Project on March 13, 1990 in Reykjavik; and
-Whereas the Parties signed a Protocol on the Progress of Negotiations on the
ATLANTAL Smelter Project, dated June 28, 1990; and
-Whereas the Government intends to present to the Parliament this autumn a Bill of Law
on an Enabling Act on the ATLANTAL project; and
-Whereas the Parties intend to proceed with hrther work relating to the ATLANTAL
project leading to the appropriate board approvals set out in the Declaration of Intent and
the Protocol; and
-Whereas the Parties have continued their negotiations on the ATLANTAL smelter
subsequent to the Declaration of Intent and the Protocol and are now in a position to
resolve certain major issues relating to the ATLANTAL project;
NOW IT IS HEREBY AGREED AND DECLARED AS FOLLOWS:
ARTICLE 1.
CONDUCT OF NEGOTIATIONS.
The Parties confirm that the negotiations on a new aluminium smelter in Iceland
("the ATLANTAL Smelter") have proceeded in a satisfactory manner.
ARTICLE 2.
UNDERSTANDING IN PRINCIPLE ON MATTERS RELATING TO THE MASTER
AGREEMENT.
2.1. The Parties have reached understanding in principle on the following contract issues
relating to the Master Agreement:
(a) General legal structure of the project, in particular the share holding in ATLANTAL
Ltd. ('the Company') through Holding Companies and the objects and operations of the
ATLANTAL Companies.
(b) Organization of the ATLANTAL Companies under the Icelandic Companies Act as to
be further provided in an Enabling Act, the equity of the Company, citizenship and rules
related to board members of the Company.
(c) Establishment of an Advisory Committee.
(d) Provisions governing transfer of shares in the ATLANTAL Companies and the effect
of such transfers, the vesting of security interests on shares related to project financing.
(e) Basis of operation, particularly the Company being operated on tolling basis, and the
basis for reimbursement by the Holding Companies of operating costs of the Company.
( f ) That the procedure for the granting of the Environmental Operating License will be in
accordance with Icelandic Law.
(g) The training, employment and hiring of Icelandic personnel and the use of Icelandic
materials and services.
(h) The Government's option to purchase a 5% portion of the Company's production for
further processing in Iceland.
(i) Granting of rights regarding working capital and foreign exchange.
(i) Icelandic law will govern the agreements and disputes will be generally settled under
Icelandic law by Icelandic courts or alternatively by arbitration pursuant to Icelandic law.
(k) The term of the agreement will be 25 years from the effective date with two options to
extend contract terms.
2.2. The Parties have reached understanding in principle that the ATLANTAL Companies
will generally be taxed pursuant to Icelandic law and that the following principles of
taxation will be applicable:
(a) In order to avoid double taxation of the ATLANTAL Companies in Iceland, resulting
from the corporate structure, the Company will be exempt from income tax and the
Holding Companies will be exempt from turnover tax.
(b) An income tax rate of 30% will be paid by the Holding Companies. The income tax
will be based on deemed profit pursuant to an agreed method of calculation, but excluding
certain deductions.
(c) Deductions for income tax calculation include, inter alia, the cost of alumina and a
fixed overhead rate of 4% of deemed revenue.
(d) A turnover tax of O,77% will be paid by the Company on its turnover.
(e) A property tax will be paid at a rate of 0,75% and a property tax base of 160 MUSD
with certain discounts for the first few years. The agreed value of property will be
converted into Icelandic kronur on the average exchange rate in October 1990 indexed to
the building index for October 1990.
( f ) Double taxation of the ATLANTAL Companies will be governed by principles of
existing international conventions and, in their absence, by the Nordic Convention on
Avoidance of Double Taxation.
(g) Exemptions will be provided from import, export and excise duties for construction,
maintenance and operating material, equipment and supplies, importation of raw materials,
export of metal and used materials.
(h) Exemptions from VAT will be provided for electric power, main imported raw
materials and the cost reimbursement.
(i) Stamp duties will be 0,15 per cent. Shares and documents relating to refinancing shall
be exempt from stamp duties.
6) The principles of reviewing tax arrangements will be provided for.
(k) Principles of Accounting will be provided for in the Master Agreement allowing
among other things for depreciation of assets in full.
(1) Disputes relating to taxation shall be settled before Icelandic courts and can only be
referred to arbitration if they are of principal importance to the performance of rights and
obligations of the Parties to the Master Agreement.
2.3. Working drafts of the Master Agreement generally reflecting the understanding set
out in Sections 2.1. and 2.2. above have been circulated among the Parties.
ARTICLE 3.
UNDERSTANDING IN PRINCIPLE ON MATTERS RELATING TO THE POWER
CONTRACT.
3.1. The ATLANTAL companies and the National Power Company are carrying out
negotiations on a power contract for the ATLANTAL project. The negotiations are
proceeding and progressing in a satisfactory manner. Understanding in principle has been
reached on certain major issues related to the Power Contract as set out in Annex 1
hereto.
3.2. Working drafts of the Power contract have been exchanged between the Parties.
ARTICLE 4.
ENVIRONMENTAL AFFAIRS - LICENSES.
4.1. The ATLANTAL smelter will be built utilizing state of the art technology for the
production of primary aluminium, the cast house operations and for environmental
protection.
4.2. Following discussions in June of this year between representatives of the Ministry of
the Environment and the ATLANTAL group, the group have submitted an application on
an environmental operating license. Understanding has been reached in principle on the
following issues relating to the procedure and legal framework there of
(a) The application will be processed according to Icelandic law and regulations.
(b) The license will be issued and maintained for a period equal to the term and any
extended term of the Master Agreement.
(c) The license may only be revised or modified (at intervals to be agreed upon) if,
i) As a consequence of global environmental conventions new devices, measures or
equipment to control air, water or solid waste emissions, effluent or discharges
have generally been imposed and implemented in OECD countries on primary
aluminium smelters designed at approximately the same time as the ATLANTAL
smelter and that incorporate similar design and technology as the ATLANTAL
smelter; and
ii) New devices, measures or equipment are required by Icelandic law; and
iii) Local conditions at Keilisnes require that the new emission controls be
implemented.
(d) Implementation at the ATLANTAL smelter of any license modification will be phased
in over a reasonable time frame and shall take into account the financial conditions relating
to such implementation in OECD countries. The smelter shall in every respect be accorded
treatment under Icelandic law, regulations and administrative practices no less favorable
than that accorded in like situations to other Icelandic enterprises.
4.3. Concurrent with or prior to the closing date for signing of the agreements entered into
on the ATLANTAL project, an Environmental Operating License, and Industrial License,
a Commercial License and a Building Permit for the project will have been issued.
ARTICLE 5.
SITE AND HARBOUR AGREEMENT.
The ATLANTAL Smelter will be constructed at Keilisnes on Vatnsleysustrond
and will have an initial rated capacity of approximately 200.000 mtpy. Negotiations with
the respective Municipalities will be continued in order to complete a smelter site and
harbour agreement as set out in Annex 2 hereto.
ARTICLE 6.
OTHER BASIC AGREEMENTS ON THE PROJECT.
The ATLANTAL group have been negotiating agreements concerning the
establishment, organization and operation of the ATLANTAL Companies and will also
have to obtain off-balance sheet Project Financing on terms acceptable to the individual
firm.
ARTICLE 7.
FURTHER WORK.
The Parties will proceed with their negotiations on all outstanding issues and on all
other preparations, such as those referred to in the Declaration of Intent and the Protocol.
The ATLANTAL group reiterate their intent to present individually the overall project to
their respective parent company boards for consideration and decision according to the
time schedule established therein.
ANNEX 1. UNDERSTANDINGS IN PRINCIPLE ON THE POWER CONTRACT.
Understanding in principle has been reached on the following contract issues in the
Power Contract to be entered into for the ATLANTAL Project between the National
Power Company and the Company:
(a) The power price which will be calculated as a certain percentage of aluminium price
with an initial period of discounts and a floor and cap for the years 1994 through 1996.
@) The power supply will be for approximately 3000 GWh per year, with 90% delivered
as firm power.
(c) The obligations of the Company will include an obligation to take or pay for 90% of
the firm power during any 10 consecutive years.
(d) The contract will contain a fairness clause.
(e) Certain of the terms and conditions for power delivery with delivery starting in 1994.
(0 The power contract period will be for 25 years with the Company having the option to
extend the contract period by two additional five year periods.
The power contract, when finalized, is subject to board approvals.
ANNEX 2. UNDERSTANDING IN PRINCIPLE ON HARBOUR AND SMELTER
SITE AGREEMENT.
Understanding has been reached in principle on the following basic issues relating
to the Smelter Site and Harbour Agreement:
(a) The Company will have the option to purchase or lease the necessary site at Keilisnes
for a smelter with a capacity of approximately 400.000 metric ton per year as well as the
necessary site for the harbour connected with the smelter.
(b) The Company will have the option to build and operate the harbour, with the
Municipalities having secondary right of usage for other purposes.
(c) The Municipalities of the Sudurnes Region or the Municipality of
Vatnsleysustrandarhreppur, as the case may be, will provide services such as water supply,
waste disposal etc. as requested with prices established on cost basis.
Signed in Reykjavik on October 4, 1990.
For the Government of Iceland:
By: Jon SigurBsson
For The Icelandic Negotiating Committee:
By: Johannes Nordal
For the Municipalities of the Sudurnes Region:
By: Oddur Einarsson
For the Municipality of Vatnsleysustrandarhreppur:
By: Jon Gunnarsson
For Alumax Inc.:
By: Robert R. Goble
For Griinges AB:
By: Ulf Bohlin
For Hoogovens Aluminium BV:
By: Hans G. D. van der Ros
(Icelandic Government and the ATLANTAL group, 1990 pp. 5-10).